By Brian Lund (TMF Tardior)
April 19, 2000
I had this great theory -- at least, it sounded great at the time -- that I shared with a number of other America Online (NYSE: AOL) bears. This theory called for AOL to see its subscription numbers drop as the world caught on to free Internet Service Providers (ISPs) like NetZero (Nasdaq: NZRO) and Rule-Breaker Excite@Home's (Nasdaq: ATHM) narrowband FreeLane. Membership would also dive when folks caught on to broadband, I reckoned. The upshot of it all was that AOL's subscriber model was not long for this world.
I'm starting to have my doubts.
Too early to tell, maybe, too early to say. Somehow, however, in spite of free ISPs, in spite of broadband expansion, in spite of the fact that AOL costs more even than other pay ISPs, AOL continues to expand its membership. Yesterday's third-quarter earnings announcement was the latest installment in the seemingly interminable series of astounding subscriber growth numbers.
This table gives membership (in thousands) for the year-ago quarter, the previous quarter, and the third quarter.
Overall, AOL has boosted its membership 36% over the last year and continues on a 33% run rate. That's amazing.
"Aha!" the skeptic in me cries, wishing he were Errol Flynn, "the trend is slowing! In the second quarter of this year, membership grew 14% quarter-over-quarter and 39% year-over-year. What's more, CompuServe and Gateway.net memberships come from special deals that don't have as high subscription rates as AOL's service!"
He's right. If we speak in percentage terms, growth is slowing. Even if we speak in raw numbers, growth slowed from the second quarter to the third. AOL inked 2.9 million subscriptions in Q2, but only 2 million in Q3.
But wait! The second quarter included the holiday season, when Joe Q. Consumer bought little Jane a brand new Gateway in the cow box with the ISP subscription built in! Let's compare raw year-over-year numbers. Between the second quarter of fiscal 1999 and 2000's Q2, AOL signed up 6.7 million folks worldwide. Between the third quarters of 1999 and 2000, it roped 6.75 million. Smaller percentage, bigger number.
How about slowing subscription revenue growth? Quarterly subscription revenues reached $1.15 billion, up 33% from the year-ago quarter and 7.8% from the second quarter. The second quarter saw 36% year-over-year and 7.2% quarter-over-quarter. Hey, that's a lot closer than the subscription growth. Subscriptions boosted sales by $86 million sequentially and $284 million annually this quarter, compared with $72 million and $281 million in the second quarter.
Hard to argue that subscription revenue growth is slowing. We know that it must happen eventually, though. Surely it must drop off someday. Mustn't it?
Well, AOL's preparing for that day, whether it comes or not. The most impressive thing about AOL's earnings is that the company is reducing its dependence on subscription revenues. A year ago, AOL was deriving almost 70% of its sales from membership fees. This quarter, that number has dropped to 63%.
That's still a significant portion -- no one is going to argue that it's not significant. But it's going in the right direction.
The replacement sales came from advertising and commerce. Revenues from this sector climbed to $557 million -- an increase of 103% over the year-ago quarter and 27% over this year's second quarter.
That's what I want to see. Sticking to my original thesis, AOL has got to draw most of its future cash from its viewers, not its members. It's got to turn the people who move through its site into cash (I love that image. It makes me think of Pink Floyd: The Wall ). That's exactly what AOL is doing.
What's more, to put a little icing on that cake, AOL is earning that revenue with less effort. Sales and marketing expenses declined to 14.5% of revenues, compared with 17.4% a year ago. That's led to operating margins of 21%, way up from about 10% a year ago and 17.5% the previous quarter, excluding one-time charges.
Now we're talking. Not only is AOL profitable, but its margins are rapidly improving. Are you listening, "why-are-dumb-individual-investors-chasing-unprofitable-New-Economy-companies" bears? Oh, you weren't talking about AOL -- not anymore, anyway.
For those of you who keep score by analysts' estimates, AOL beat 'em. Net income without one-time items came out to $0.11 per share, a penny ahead of the Street. Isn't it just like the Street to be a penny short and, oh, about five years late?
We'll have more news on AOL's earnings in the coming weeks, but, in the meantime, let's hash 'em out on the discussion board !
Hate to end on a depressing note, but I don't want to leave out the other reporting Breaker, Excite@Home.
Excited investors anticipated today's earnings by kicking the stock down more than 12%. Biased observers will note that that sort of beating is nothing new for Excite@Home, which now sits about 47% lower than where it was three weeks ago (and I don't even want to talk about how far off its 52-week high THAT was).
The big number in this earnings release was the subscription growth. Excite@Home increased its subs by 350,000, or 30%, over last quarters figures, putting total membership at 1.5 million. That's a little under the 40% pace that the company suggested it could achieve, and slower than last quarter's 36%. Still, its goals are to have a total of at least three million residential broadband subscribers by the end of 2000, growing to six million subscribers by the end of 2001 and ten million subscribers by the end of 2002.
Excite@Home now has 26 million upgraded cable homes passed, up about 75% from a year ago. Its penetration rate (that's the number of potential subscribers who have actually signed up) has also increased to 5.7%, up from 4.8% last quarter and 3.1% a year ago. That's a really positive sign. Its global broadband footprint now totals 87 million homes.
The number Wall Steet will probably focus on (or maybe already focused on), however, is the earnings per share (EPS). The company reported a pro forma loss of $4.6 million for the quarter, or one cent per share, on $138 million in revenue. First Call says that analysts expected Excite@Home to break even. If you toss in all the amortization et al., the company lost $676 million, or $1.75 per share.
Hey, what's a few million between friends?
Commiseration will take place on the Excite@Home discussion boards after the services -- er, conference call.
-- Brian Lund, TMF Tardior to his parents.
