Didn’t We Already Know That?

Sometimes enough just isn’t enough. After announcing on Monday that it expected to meet analysts’ expectations for quarterly profits and subscriber growth, America Online Inc. saw its shares tumble, ending the day at $90.13, a 6.4 percent drop from Friday. AOL was down further early Tuesday afternoon, trading at $89.44.

You would think the market would react positively to such reassurances
by AOL (AOL) executives, but investors instead appear skittish primarily about
the company’s profits in the face of competition that could force it to
lower subscription fees.

The concerns were fueled over the weekend by a column in Barron’s in
which Doug Kass of Seabreeze
Partners said AOL shares could lose another 50% in value. (The
company’s stock has dropped about that much since its April highs.)

According to the column, Kass (who’s never directly quoted) thinks AOL
may see tougher times ahead because its subscriber growth rate has
slowed and price competition will cut into revenue.

Both are valid points, and I’ve written recently that one of AOL’s
biggest challenges is to decrease its dependence on subscription
revenues. In the fiscal year ended June 30, subscription fees comprised
69.5% of AOL’s total revenue, compared to 70.6% in fiscal 1998. That’s
slow progress, and the company has to do better if it is to decrease its
reliance on subscription revenue.

But what Kass – and the market, at least in the short-term – aren’t
factoring in is AOL’s proven ability to adapt and evolve. The company
has overcome crises before.

In 1996 it was besieged by furious subscribers complaining about poor
service, including the inability to connect to AOL despite paying a
monthly fee. This led to a class-action suit and predictions of AOL’s
imminent demise. In spring ’98 AOL faced a backlash when it raised its
monthly fee from $19.95 to $21.95.

Yet the company continues to grow, if not at the same furious pace. In
the quarter ending this month, AOL will add about 900,000 subscribers to
its base of more than 20 million (counting 2 million CompuServe

Further, AOL continues to cut deals with other companies, such as online
auction giant eBay, that promise to diversify its revenue stream.

The bottom line is that while AOL must cope with serious challenges on a
number of fronts, it continues to hold distinct competitive advantages.
None of these went away because a hedge fund manager (and short seller
of AOL shares, according to Barron’s) brought up some of the admittedly
legitimate problems facing the company. Investors shouldn’t lose sightof the big picture.

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