Ad, Commerce Dips Hit AOL Time Warner

Cash flow grew 20 percent at AOL Time Warner Inc. in the second quarter, fueled by substantial gains in its cable operations.

But lower-than-expected revenue growth made investors skittish, driving the company's stock down by nearly 10 percent on July 18.

Revenues increased 3 percent to $9.2 billion, below analysts' estimates of $9.7 billion. That was enough to drive the stock down $4.80 to $44.68 per share July 18, as investors saw it as a sign of future troubles in a sluggish advertising market.

In a research report, Goldman Sachs & Co. analyst Richard Greenfield said revenue growth was well below his expectation of 9 percent, due mainly to a company-wide $68 million decline in advertising and commerce revenue. Despite that shortfall, Greenfield wrote that AOL Time Warner has outperformed its peers.

"While ad/commerce revenue was lower than our expectations, [America Online's] 26 percent year-over-year increase is very strong, relative to the industry-wide downturn in online advertising," Greenfield wrote. "AOL's 26 [percent] year-over-year gain is significantly better than its next closest competitor, which experienced a 40 percent year-over-year decline, and underscores the higher value of AOL users."

AOL Time Warner CEO Gerald Levin spent a good part of the conference call with analysts trying to downplay the revenue shortfall. He stressed that the slumping ad market has actually been good for the company because it has forced management to continuously seek more efficient ways to operate.

"We're taking advantage of this environment," Levin said. "We can accelerate things that might have taken longer. Permanent cost management is the discipline of this company."

Levin added that one example of this is the focus on cross-promotion and cross collaboration within AOL Time Warner properties.

"Probably even more important are the benefits that come from cross-collaboration, in terms of driving savings and efficiencies and new sources of revenue," Levin said. "Usually when you have big companies, it's hard to turn the ship around. In this case, this is very swift movement with respect to advertising.

"We have exploited our own media in ways that have benefited the sale of our own products," said Levin.

AOL Time Warner co-chief operating officer Richard Parsons said that by taking advantage of the company's vast media assets, AOL Time Warner is able to keep a growing portion of its outside advertising dollars in-house. That, in turn, keeps costs down and improves efficiency.

Cost savings aside, cable played a significant role in AOL Time Warner's advance in the second quarter. Revenue at MSO Time Warner Cable — with about 12.7 million subscribers — grew 14 percent to $1.7 billion, while earnings before interest, taxes, depreciation and amortization rose 13 percent to $777 million.

Levin said the growth was fueled by the addition of 373,000 digital and 226,000 new high-speed data subscribers in the quarter, as AOL Time Warner ended the quarter with 2.5 million digital and 1.4 million data customers, respectively. Local advertising growth at the cable unit was 19 percent in the period.

During the conference call, AOL Time Warner chief financial officer Mike Kelly said the growth in high-speed data and digital cable helped boost the cable unit's average revenue per subscriber by 12 percent.

At the networks segment — which includes The WB broadcast outlet as well as cable channels like Cartoon Network, TBS Superstation and Cable News Network — revenue was up 2 percent and EBITDA ahead 18 percent, to $444 million. Advertising and commerce revenue was down 8 percent, primarily because of weaker ad revenue at Turner Broadcasting System Inc.

Overall, EBITDA growth at AOL Time Warner was 20 percent in the quarter, reaching $2.5 billion.

Kelly reiterated that the company was on track to meet its full-year revenue targets of $40 billion in revenue and EBITDA of $11 billion. He raised cash earnings per-share growth estimates for the year from 25 percent to 30 percent to 35 percent to 40 percent, or from $1.28 to $1.32 per share.