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Unconventional Transactions Boosted Sales

The company said that Pittman and other executives were accurate in their public statements. During AOL's Oct. 18, 2000, conference call with analysts, Stephen M. Case, then AOL's chairman and chief executive, said, "AOL's advertising growth is right on target." He added: "The current advertising environment benefits us because it will drive a flight to quality." And Kelly, then chief financial officer, called AOL's ad and commerce revenue growth "very healthy" and emphasized, "I can't say that strongly enough."

Some experts who reviewed the deals examined by The Post questioned whether some of the deals were accounted for properly. They also questioned whether investors could have adequately understood AOL's advertising business from the company's statements and other information AOL made available to the public.

AOL Time Warner directors are scheduled to approve the name change at a meeting on Thursday in New York, according to people close to the board. (File Photo - Associated Press)

_____AOL Responds_____
AOL Says Accounting 'Was Appropriate' (The Washington Post, Jul 18, 2002)
_____AOL Series_____
Part II: Creative Transactions Earned Team Rewards (July 19, 2002)
Sidebar: Unorthodox Partnership Produced Financial Gains (July 19, 2002)
_____Graphics_____
The Heart of a Deal: How America Online Brings Advertising Deals to Fruition
Excerpt of AOL E-mail
A Rocky Road: Graphical Timeline Tracks AOL Stock Price
AOL Documents and Deals Reviewed by The Washington Post
_____Time Warner_____
Stock Quote and News
Historical Chart
Company Description
Analyst Ratings
Timeline: Time Warner Highlights
Company Downsizing Actions
_____Time Warner News_____
Former AOL Chairman Heads Luxury Travel Firm (The Washington Post, Nov 23, 2004)
Time Warner Nears Deal Over AOL Accounting (The Washington Post, Nov 23, 2004)
AOL Concentrates On Security Issues With New Software (The Washington Post, Nov 18, 2004)
More AOL Time Warner News

"That's the whole purpose of financial statements -- for investors and others to understand the business," said James Cox, a Duke University law professor who is a member of the legal advisory board of the New York Stock Exchange and the National Association of Securities Dealers.

Yannucci, AOL's outside attorney, wrote June 21 that no expert could render a proper judgment on the company's accounting without "a full understanding of the agreements and transactions at issue, as well as their context as part of AOL's overall business."

In a separate letter yesterday, Yannucci added: "We believe such arm-chair speculation about AOL's accounting and financial disclosures by less than fully-informed 'experts,' directly contradicted by the fully-informed views of our outside auditors (Ernst & Young), is not only grossly unfair and unwarranted in light of the exhaustive facts we have presented to you, but is also reckless in the current highly-charged environment."

When the company eventually identified a downward trend in its advertising business, it properly disclosed it in the latter part of 2001, Yannucci wrote.

Shares of AOL Time Warner Inc., as the company was renamed after the merger, have been in retreat ever since, closing at $13.11 yesterday, down 72 percent since the deal was consummated.

Wall Street has begun to question whether the AOL-Time Warner marriage ever made sense -- for Time Warner -- in light of the online unit's weakness. The company still possesses an array of powerful assets, such as HBO, Warner Bros. and Time magazine (a competitor of Newsweek, which is owned by The Washington Post Co.). But now, company officials are struggling to turn around the online unit.

Birth of a Giant

The evolution of AOL from a small online service to a major advertising force began in late 1996.

Facing stiff price competition from other Internet service providers, AOL abandoned the hourly fee that it had been charging customers, replacing it with a flat-rate monthly charge. Users began to spend more time online, taxing AOL's network and eating into its profit margin. AOL set its sights on getting companies to buy ads to promote themselves on its vast online network.

Ad revenue was intended to keep the company growing at a fast clip after the growth of its basic business -- monthly subscriber fees -- began to ebb.

"Advertising was supposed to be the big thing to defray concerns about AOL plateauing," said Michael Bromley, a business development director for AOL consumer devices until he was laid off last year. "On Wall Street, it's not what you make, it's what you're perceived as."

By the fall of 2000, ad and commerce revenue had rocketed from virtually nothing to more than $2 billion a year -- about a third of the company's overall revenue. A prime reason was the emergence of dot-coms initially rich with venture capital and eager to promote themselves.

But the capital now was drying up and the Nasdaq Stock Market was in a free fall. Questions about ad revenue began to emerge on Wall Street just as AOL sought to complete its Time Warner merger.

Several analysts at the time took AOL's reports of a big jump in ad and commerce revenue in the Sept. 30 quarter as a sign of the company's strength in the face of a slowing ad market, and they encouraged investors to buy AOL shares as the merger neared.

In a research note a day after AOL's Oct. 18 conference call, analyst Youssef H. Squali, then of ING Barings LLC, reiterated his "strong buy" rating on AOL's stock. "Solid advertising revenues attest to AOL's hybrid subscription/advertising model, which so far has provided the company with more protection from the dotcom meltdown than other large new media companies," he wrote.

Mary Meeker, an analyst at Morgan Stanley Dean Witter & Co., was also encouraged by AOL's ad and commerce revenue results. "This has developed quickly into AOL's fastest growing revenue stream and a key element of growth going forward," she wrote in a research note a day after AOL released its numbers.

And analyst Christopher Dixon, then of PaineWebber Inc., wrote that AOL's strong ad and commerce revenue "should alleviate some concerns about the health of the Internet advertising environment."

What the analysts failed to note -- or didn't know -- was that many dot-coms no longer had the cash to pay for all the ads they had agreed to buy in their premium-priced long-term contracts with AOL.

At the company's Dulles offices, AOL was already holding weekly emergency meetings to discuss the status of failing dot-com ad deals, company sources said. AOL closely monitored the status of these ad deals, large and small, according to several company documents obtained by The Post.

The AOL documents gave a detailed report, week by week, of the health of the dot-coms, how much they owed AOL, what AOL was doing to get its money, how the dot-coms were responding and how much money AOL reckoned it could lose if the dot-coms didn't pay their bills.

One firm, Living.com, an online furniture business, owed AOL $1.2 million. "They are out of $, wanted to look at new deal but then backed out completely," AOL stated in a confidential summary of dozens of deal restructurings, dated Aug. 18.

AOL's conclusion: "Not solvable."

The company was right: Living.com shut down that month.


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