AOL Does Have a Strategy

AOL may be the largest ISP in the world, but even AOL has found it difficult to make broadband profitable. With some new ideas that are being implemented now, AOL may at last make money on cable broadband Internet service—or it may not.

by InternetNews Staff [August 22, 2002]

Almost every national Internet service provider in the U.S. has had a comprehensive broadband policy in place for years—except for the largest one in the world.

America Online, the subsidiary of AOL Time Warner (NYSE: AOL) that has more than 33 million dial-up subscribers in the U.S. and abroad, has been surprisingly reticent to date about advertising or otherwise promoting broadband to its dial-up following.

While its primary rivals in the U.S., MSN, Earthlink, and United Online, were busy signing deals with any and all incumbent telephone and cable networks and launching nationwide campaigns, AOL stood seemingly aloof for the most part.

Although AOL Broadband is available throughout the U.S. over a digital subscriber line (DSL), and cable broadband is available through the Time Warner Cable (TWC) network, not many AOL customers are aware of the service.

The benefits of broadband access, and the attendant revenue benefits to offering the service, can't be ignored. With more than 7.12 million cable Internet customers and 4.6 million DSL customers in the U.S. (according to In-Stat/MDR), broadband is quickly going mainstream.

What's the reason for the relatively unheard-of AOL high-speed services? The answer is simple: it hurts.

"Overall, they've been dragging their feet a little bit developing a broadband strategy because they're making money on dial-up right now," said Mark Kersey, a broadband analyst at ARS "It's a tough position for them to be in, because every day they're losing dial-up subscribers to broadband."

"The struggle for them is 'how do we have a broadband strategy while not essentially depleting our margins?'"

The struggle for broadband profitability began with a new deal. Under the terms announced Wednesday, AOL would pay AT&T $2.1 billion in cash and $1.5 billion in stock in order to buy out AT&T's 27.64 percent stake in Time Warner Entertainment (TWE).

The deal would create a new subsidiary for AOL Time Warner called Time Warner Cable, which would include cable assets and subscribers currently believed to number 10.8 million.

AT&T Broadband and Comcast (the two are in the midst of a merger that would create the nation's largest cable operator with about 22 million subscribers) also struck a three-year non-exclusive agreement with AOL. The deal would offer AOL High-Speed Broadband service to about 10 million subscribers within the merged AT&T Comcast cable systems. Within its Road Runner division, AOL Time Warner currently serves an estimated 2.5 million high speed customers.

The high-speed service is expected to be first marketed in Boston, Indianapolis, Seattle, and Nashville.

The deal, valued at between $8.5 billion and $9 billion, helps untie all three media companies from complications besetting their own agendas.

AT&T's broadband division, for one, would have one less subsidiary for regulators to ponder as well as more cash on hand as it looks for regulatory approval of its planned merger with Philadelphia-based Comcast (the terms of the TWE buyout are not contingent on the merger with Comcast closing).

In addition, AT&T Broadband would hold a 21 percent equity interest (with less than 5 percent voting power in the election of directors) in AOL Time Warner's new cable subsidiary Time Warner Cable.

AOL, for its part, plans to pay AT&T for the nearly 28 percent chunk of TWE by floating an IPO of the Time Warner Cable division, perhaps during the first half of next year. During a conference call Wednesday to discuss the deal, AOL Time Warner officials stressed the careful, step-by-step process involved in each facet of the TWE arrangement.

But when each aspect of the deal is eventually sewn up, the world's largest media company is expected to hold close to 80 percent of the new Time Warner Cable subsidiary. And, as AOL Time Warner CEO Richard Parsons put it, "all of the company's state-of-the-art cable assets will be combined for the first time into a well-capitalized, pure-play cable company," with a "significant nonaffiliated third-party broadband cable carriage for AOL High Speed Broadband."

While all three companies are trumpeting victory in restructuring the complex ownership stake, the deal clearly gives AOL some good news to announce for a change. The announcement follows weeks of management shakeups in the media company, along with news of regulatory and federal investigations into AOL's accounting practices and a steady slide in its stock price.

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