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God I wish I Could Still Short AOL

As I was watching my beloved Steelers miraculously avoid embarrassment at the hands of the Jets this weekend, I did something I seldom do these days (thanks to my DirecTivo), I watched commercials.  Most of the commercials were standard football fare (beers, cars, IBM, ED treatments), but there was one set of commercials that were clearly out of place.  They were for America Online.

Perhaps you also saw the spots I am taking about.  All them featured rather ordinary people sarcastically begging for their computers to be afflicted with some kind of computer virus.  The sales pitch, which is at its core was a blatant scare tactic, was that AOL offers their users free Virus-protection software and you, dear consumer, had better get AOL before some similar malady befalls your computer.

As I saw these ads, it confirmed to me 4 things about AOL:  1.  That the once proud "proprietary fortress" has nothing positive left to keep its members within the confines of its clunky client except for cheesy scare tactics.  2.  That the management of AOL is in complete denial about the severity of the crisis their business faces.  3.  I wish I could short their stock.  4.  Steve Case is one of the smartest investors in history and should be folk hero to all pre-merger AOL shareholders instead of the corporate scapegoat that he has become.

Let me briefly address each of thoughts in turn.  First, it is clear that the "walled gardens" of the old dial-services have been completely torn asunder by the power of the Internet and broadband.  AOL's party line has been that proprietary content (presumably Time Warner magazines, videos, etc.) and services (most prominently e-mail and to a lesser extend AIM) would enable them to survive in a broadband world and would keep their customers from defecting.   With each passing day I think this party line looks increasingly like the wishful thinking it is.  If AOL's proprietary services are so great, why are they spending tens of millions on marketing campaigns focused on scare tactics instead of touting their great proprietary content? Because they know that the Internet offers several orders of magnitude more content and services, mostly for free, and they will never be able to compete with that.

My second thought was that while AOL's management team either implicitly or explicitly has accepted that they have lost the content war (and must therefore resort to scare tactics), that they have not accepted that their business is headed, Titanic-like, straight into a massive iceberg called broadband.  AOL does not stand a chance competing against the RBOCs and the MSOs for broadband customers.  Why in world will someone pay an additional $20/month ($240/year) for AOL when they are already paying more for broadband access to begin with?  At first they might pay to keep their e-mail address, but overtime the pull of the Internet (and their wallet) will be inexorable.  This point was driven home to me when my own parents recently sent around e-mails saying that they were switching from a Compuserv (one of AOL's low cost brands) e-mail account to a ComCast e-mail account.  They switched to broadband about 6 months ago but only made the e-mail switch after Comcast made available a very easy to use "e-mail address change" application.   For them it was a no-brainer as it is bound to be for everyone else.  If AOL was serious about avoiding the iceberg they would either be A) drastically cutting their prices  B) spinning off their access business C) selling themselves to an MSO, RBOC, or Wireless carrier.

This led me to engage in a a bit of fantasy and wish that I was still able to short AOL's stock instead of having it buried within the bowls of TWE.  With management in denial, broadband competitors stealing their high-end customers and competitors like NetZero stealing their low-end customers, AOL is clearly getting ripped apart.   I say this despite the fact that I believe they still have a salvation strategy in which they essentially replicate what Yahoo!/MSN have built.  While they claim to be doing this (via, the ads they are running suggest that they are still investing their incremental dollars in the old, soon to fail, business model instead of the new one.  The right hand clearly doesn't know what the left is doing and that's what makes a great short.

Departing from my fantasy, I feel compelled to come to the defense of Steve Case who has generally gotten a bad rap in the press (and the Time Warner board room) following the merger.  All of what I outlined above was hypothesized well before the early 2000 merger of TWE and AOL and one has to assume that Steve was well aware of this.  Sure he may have believed that proprietary content would save AOL, but more likely he believed his own stock was seriously overvalued in the face of the competitive threats he faced and thus it was a great time to acquire a real business with significant cash flows based on truly proprietary content (Movies, books, magazines) and monopolies (Cable Systems).  What a sales job he did to get the Time Warner board to agree to that deal and what a favor he did to AOL's shareholders.  Steve, you da man!

January 20, 2005 in Stocks | Permalink

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The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.