Trouble at the Top

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AT&T Broadband and AOL Time Warner Inc., under pressure from investors to right what the market perceives as two floundering ships, did little to calm the waters last week after both companies released their first-quarter results.

Broadband — which is in the process of being sold to Comcast Corp. in a $72 billion deal announced in December — continued to bleed subscribers in the period ended March 31, losing 179,000 basic customers, or about 1.5 percent of its total cable base.

And AOL Time Warner, while posting better numbers on the cable side, spent much of an April 24 conference call assuring analysts that it was focusing on righting its America Online Internet-service unit, which has also experienced sluggish subscriber growth.

As expected, AOL Time Warner also took a $54 billion goodwill charge to its earnings, tied to the decline in its stock price since the merger of America Online Inc. and Time Warner Inc. in January 2001.

That charge led to a net loss for the quarter of $54.24 billion, or $12.25 per share.

AT&T Broadband and AOL Time Warner are the No. 1 and No. 2 U.S. MSOs, with 13.4 million and 12.8 million subscribers, respectively.

During his analyst call, AT&T Broadband CEO Bill Schleyer called the subscriber loss "unsettling," but added that about 80 percent of the MSO's loss was due to customer disconnects for bill nonpayment.

The other 20 percent, or about 36,000 customers, were lost to competition from direct-broadcast satellite.

AT&T Corp. chairman C. Michael Armstrong said that while the subscriber loss was expected, it did not sit well with him or other top management.

"We are not happy with the video results," Armstrong said.

Broadband expects the subscriber losses to continue in the second quarter, Schleyer added, estimating that about 64,000 customers would be pared from the rolls.

MORE MARGIN HITS

But subscriber loss isn't the only problem for AT&T.

Cash-flow margins, or cash flow as a percentage of revenue — which was on the upswing over the past few quarters — plunged nearly 4 percentage points in the first quarter to 19 percent, down from 22.9 percent in the fourth quarter of 2001.

In a research report, Salomon Smith Barney Inc. cable analyst Niraj Gupta said although he expected Broadband to lose subscribers — he previously estimated the MSO would lose 100,000 customers — he did not anticipate such an "eye-popping" number.

"While the greater than expected sub loss is clearly not good news, to the extent the majority of the sub loss is due to 'cleaning up' the subscriber base, the underlying basic decline doesn't appear to be as bad as it had first appeared." Gupta wrote.

SLOWER DIGI GROWTH

AT&T Broadband's first-quarter pro forma revenue, adjusted for significant closed cable dispositions and acquisitions, was $2.44 billion, up 13.9 percent. Cash flow was $465 million, an 18 percent increase over the $394 million in cash flow reported in the first quarter last year, but down 14.5 percent from the fourth-quarter figure of $544 million.

Digital-subscriber growth also slowed, to 250,000 additions in the quarter, compared to 335,000 fourth-quarter adds. Telephony and high-speed data additions were up slightly compared to the fourth quarter, to 110,000 and 140,000, respectively.

Schleyer said Broadband will continue to focus on upgrades and new-service rollouts. A plan to repackage its digital-cable offering will begin in this summer with two new offerings, he added. He did not elaborate.

At AOL Time Warner, incoming CEO Richard Parsons spent much of his time explaining the plan to turn the America Online service around. Last month, the company added responsibility for the online unit to co-chief operating officer Bob Pittman's duties. Barry Schuler, who had headed up the unit, was made chairman of the new AOL Digital Services Development Group.

Aside from the sluggish subscriber growth, AOL's advertising and commerce revenue fell far below expectations in the first quarter, leading the company to revise its guidance for the rest of the year.

Parsons said that total advertising and commerce revenue at the online unit will be between $1.8 billion and $2.2 billion for 2002, compared to $2.7 billion reported in 2001. Cash flow at the units is expected to be in the same range — between $1.8 billion and $2.2 billion in 2002, compared to $2.3 billion last year.

"As we move through the year and into the next, we expect AOL to turn the corner on the advertising business and thereafter become a key driver of growth for the company," Parsons said.

Overall, AOL Time Warner reported revenue and cash-flow growth of 4 percent and 3 percent, respectively. Although those numbers were down from the previous quarter, it could have been worse.

Strong performances at its Time Warner Cable systems helped to ease the blow in the quarter.

At the cable systems, revenue was up 19 percent and cash flow rose 10 percent, slightly below expectations.

At its networks — which include The WB Television Network, Cable News Network, Turner Broadcasting System Inc. and Home Box Office Inc. — revenue was up 5 percent but cash flow dipped 4 percent, affected by the advertising slump.

Despite the advertising and commerce downturn, most analysts believe that AOL stock has hit or is near its bottom.

ALREADY DISCOUNTED

Most of the bad news at AOL has already been factored into its stock price, which is down about 41 percent this year, said Goldman Sachs & Co. cable analysts Richard Greenfield and Anthony Noto.

Although Greenfield and Noto reduced their 2002 cash-flow estimates for AOL Time Warner by $635 million to $9.7 billion, the pair took heart from the fact that company management has finally addressed its view of the bottom for the AOL unit by the strength of the cable operations.

UBS Warburg LLC analyst Christopher Dixon also found a bright spot in cable in his report, but added that a turnaround for America Online is critical.

"Cable is well-positioned to continue to post double-digit cash-flow growth as penetration for high-speed and digital services improves," Dixon wrote. "The critical issue remains AOL."

Should management effect a successful turnaround of the online unit, Dixon added, the combined company could post an estimated 12-percent six-year intermediate growth rate from $9.76 billion in cash flow in 2002.

That growth suggests a $29 target price for the stock, which closed at $19.30 on April 24.

But AOL Time Warner has other issues hanging over its head, particularly the fates of its Time Warner Entertainment partnership with AT&T Corp. and its TWE-Advance/Newhouse joint venture.

AOL Time Warner has been negotiating for two years to unwind the TWE partnership; AT&T owns 25.6 percent of the venture. The two companies have been at loggerheads over the value of AT&T's stake — AT&T claims it's worth about $10 billion, while AOL Time Warner has placed a considerably lower value on it.

According to an April 26 report in The Wall Street Journal, one option AOL TW has considered involves selling a minority stake in its Time Warner Cable unit to the public, and having AT&T swap its TWE stake for Time Warner Cable shares.

AOL Time Warner spokes- woman Tricia Primrose declined comment.

TOUGH IPO CONDITIONS

According to sources familiar with the matter, selling a piece of Time Warner Cable makes sense, but is just one of several different options being considered.

While the Journal
story said that a publicly traded Time Warner Cable could have a market capitalization of as high as $45 billion, the current low value of cable stocks could dampen investor reaction to an initial public offering.

In the April 24 analyst call, Parsons said negotiations with AT&T concerning the TWE stake were ongoing.

"We have no requirement to buy back AT&T's stake," Parsons said. "I believe we will be successful, however, in working out a solution that will be constructed in a manner that is sensitive to protecting our balance sheet with strategic benefits for AOL Time Warner, as well as for AT&T Comcast [Corp.]."

But things may be getting a little trickier in the negotiations with Advance/Newhouse.

Advance/Newhouse owns about 33 percent of the TWE-A/N partnership, and since March 31 has had the right to renegotiate its interest, including opting out of the arrangement by taking either cash or cable subscribers.

Some observers feared that A/N, which is privately held by publishing's Newhouse family, might opt to take as many as 2 million cable subscribers from the unit, which could prove to be a blow for AOL Time Warner.

According to the Journal
article, Advance/Newhouse is leaning toward taking subscribers out of the partnership.

Primrose also declined to comment on TWE-A/N.

But in last week's conference call, Parsons said negotiations are ongoing.

"I am hopeful we can reach a result that will keep them in the family," Parsons said. "But let me dispel one rumor. We are not considering buying their stake for cash, nor are they considering selling it for cash."

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