When AOL Time Warner Inc. reported financial results Wednesday, the record $98.2 billion annual loss posted by the giant company, and the surprise resignation of media maverick Ted Turner, garnered headlines around the world.
But beneath the surface, another figure marked a seminal moment for Dulles-based America Online Inc., the media company's Internet unit: The number of U.S. subscribers fell for the first time ever on a quarterly basis, dropping by 170,000 in the last three months of 2002. The dip occurred despite the aggressive launch last fall of the company's newest software, AOL 8.0; the distribution of millions of free AOL computer disks; and the outlay of more than $1 billion on advertising and promotion during the year.
"The modest decline in AOL's subscriber base will spark renewed fears over AOL's long-term viability," investment firm J.P. Morgan Chase & Co. told investors.
The drop in the number of AOL subscribers is further evidence of the immense difficulties facing an enterprise that once grew so rapidly that its biggest problem was providing enough telephone lines so that users attempting to access the Internet would not encounter busy signals. Now, AOL has experienced not only a drop in its customer base but also a plunge in advertising revenue.
Goldman Sachs termed the rocky situation at AOL Time Warner "The Perfect Storm Strikes Again." CNBC, the cable business-news channel, labeled it "AO-Hell."
AOL Time Warner's stock price dropped 14 percent yesterday, to $12, down $1.96 on volume of about 61 million shares. Analysts from Bear Stearns Cos., J.P. Morgan, Lehman Brothers, Merrill Lynch & Co. and other firms warned investors that the company's near-term financial prospects appear bleak.
Wayne H. Pace, AOL Time Warner's chief financial officer, summed up the America Online situation succinctly, saying the company that brought the Internet to the masses must shift its strategy from increasing the number of users to encouraging existing subscribers to spend more time and money online. That is especially important, he noted, because the cost of recruiting new AOL subscribers is rising.
Regardless of the difficulties, America Online remains the leading company providing computer users with access to the Internet, as well as a cash cow that produced more than $8 billion in revenue in 2002. With its 26.5 million subscribers in the United States and 35.2 million users worldwide, AOL has more than three times as many customers as Microsoft Corp.'s rival MSN service, which has 9 million U.S. subscribers and failed to grow in 2002 even though the company spent $300 million on marketing.
For more than a decade, America Online experienced phenomenal growth in its number of subscribers. From 1998 to 1999 alone, it went from 11 million subscribers worldwide to 18 million. But according to industry analysts, both AOL and MSN are now mature businesses that are driven by dial-up users and are no longer growing.
Most of AOL's customers pay $23.95 a month to access the Internet through regular phone lines. But the opportunity for growth, analysts said, is in high-speed "broadband" Internet connections, which are siphoning customers from America Online and MSN.
"At AOL, there is no question that the migration to broadband, and the continued deployment of broadband offerings by Comcast and other cable operators, is going to be taking a toll," said Christopher Dixon, an analyst at UBS Warburg.
Pace said that after failing to get into the broadband game early, AOL is still playing catch-up. He said AOL has not heavily promoted a high-speed version of its own service yet because it is still developing features that would take advantage of faster connections.
On the other hand, analysts said, America Online still has a tremendous number of users, and an opportunity to forge ahead, if it makes savvy moves in broadband.
"It underscores the need to develop a variety of feature sets -- video e-mail or 'You've Got Movies' -- to make sure that AOL is going to be able to take advantage of . . . this new technology platform," Dixon said. "It is also important to recognize that we are in the early goings of broadband. There is still less than 20 percent penetration of overall households and 25 percent penetration of computer households."
J.P. Morgan agreed, telling the firm's investors yesterday, "We continue to believe that the AOL business is fixable and that the core Time Warner businesses remain valuable."
Those valuable businesses include the premium cable channel HBO, Warner Bros. and New Line Cinema Inc., CNN, and a successful magazine division with titles led by People and Time.
Despite the small decline in the number of AOL subscribers in the United States during the fourth quarter, the total number of subscribers grew enough during the other nine months of the year to enable America Online to post a 1.2 million net increase in customers during 2002.
Pace said America Online will see a decline of up to 50 percent in advertising revenue in 2003 before any turnaround in the business in 2004. Fortunately, analysts said, AOL subscribers spend more than $7 billion annually, a sum that gives the company resources to reinvest in both its core product and high-speed services.
At the same time, AOL is losing some subscribers to bare-bones online services that connect customers to the Internet for just $9.95 a month, company officials said. EarthLink Inc., the nation's third-biggest Internet provider, said it plans to begin targeting the low-price segment of the market. It also announced this week that it was laying off 25 percent of its workforce.