America Online Inc. yesterday announced it will invest $1.5 billion -- more than half of the company's free cash -- in General Motors' Hughes Electronics Corp., one of AOL's allies in developing Internet access over satellite television signals.
The deal is AOL's clearest answer yet to the question of how it will compete with AT&T Corp. and others in the crowded race to deliver high-speed Internet access. Wall Street analysts have pushed for AOL to strike a deal with a cable television provider to get high-speed access to people's homes. Cable modems can send data 40 times as fast as traditional telephone modems. The alliance with Hughes doesn't meet that standard, but it will let AOL deliver Internet service up to 14 times faster.
"Shareholders are looking for something definitive regarding cable" from AOL, said David Simons, managing director of Digital Video Investments in New York. Still, he said, the investment in Hughes shows AOL is willing to pay to deliver faster Internet access.
Steve Case, AOL's chairman and chief executive, said the Hughes investment was not a replacement for a cable alliance. "We are continuing to have an interest in cable," he said, adding that AOL was hoping to create a "broadband tapestry" that could deliver AOL's service through a range of technologies.
AOL shares, which have fallen from their peak of $175.50, rose $3.37 1/2 yesterday to close at $115.37 1/2.
AOL's cash investment extends an alliance formed last month between the Dulles-based company, the largest online service provider in the world, with 17 million subscribers, and Hughes, the digital television and satellite data giant. The two will jointly develop a television set-top receiver to sell consumers Hughes' DirecTV -- which already has 7 million subscribers -- and AOL TV -- which is not yet being marketed -- starting early next year.
AOL TV is the cornerstone of the company's "AOL Anywhere" strategy, which is designed to provide Internet connections through devices other than computers. AOL envisions people watching television while at the same time using the screen to navigate chats with friends about a certain show or to purchase a CD while watching a music video.
The market for such an offering is not yet certain: Microsoft Corp., which sells a similar service called WebTV, has so far attracted only 700,000 customers. And At Home, which provides Internet access over cable modems to home computers, has 460,000 subscribers. AT&T is a major investor in At Home. Analysts expect AT&T is working on a television-based Internet access service, too, especially given its recent big-ticket purchases of cable companies Tele-Communications Inc. and MediaOne Group.
AOL tried to buy part of MediaOne, but AT&T won that bidding war last month, agreeing to pay $58 billion. Microsoft got a piece of the MediaOne pie, too, because it invested $5 billion in AT&T as part of the deal.
AOL has been lobbying Congress to require that owners of cable lines allow AOL and other Internet service providers to access those lines for a fee. Although a judge in Oregon earlier this month ruled in favor of allowing more open access to cable lines, the Federal Communications Commission is opposed to such a requirement.
Case said in an interview that the Hughes deal, the largest cash investment in AOL's history, will speed up the AOL TV plan. "The financial commitment accelerates everything," he said.
Case also said AOL will likely sell more stock or debt to the public to shore up its cash reserves. Its equity investment in Hughes will earn it a 6.25 percent annual return, and, under terms of the deal, will convert to 4 percent of the outstanding General Motors Class H stock in three years.
The deal also calls for Hughes and AOL to jointly develop new content and interactive services in the United States and abroad.
The two companies said they will launch an extensive cross-marketing campaign to package and sell the TV service. Mike Smith, chairman and chief executive of El Segundo, Calif.-based Hughes, ended a conference call yesterday for reporters and analysts with: "Steve, you're a good salesman for us."
The agreement also will let AOL offer its customers a high-speed upgrade, known as AOL-Plus,through Hughes' DirectPC satellite Internet network early next year. AOL had already announced deals with regional Bell companies SBC Communications and Bell Atlantic to deliver digital subscriber line (DSL) service to its subscribers. DSLs can transmit data at speeds up to 20 times as fast as traditional modems.
"We plan to make AOL-Plus available through all high-speed technologies," Case said in the conference call. "We're agnostic as to these underlying technologies."
William Whyman, an analyst with Legg Mason Wood Walker in Washington, said the Hughes deal is "one of the ways [AOL is] hedging the outcome of whether they get access to the cable platform."
Company: Hughes Electronics
Based: El Segundo, Calif.
Business: Designs and makes satellites and satellite-based telecommunications systems. Is a subsidiary of General Motors.
Chief executive: Michael T. Smith
1998 revenue: $6.0 billion
1998 earnings: $250.7 million
Web address: www. hughes.com
Yesterday's closing stock price: $56.62A, up $3.18E (ticker GMH on the NYSE)
SOURCE: Hoover's, Bloomberg News