Tangled Web Awaits New CEO of AOL

Just one day after a shake-up at AOL Time Warner Inc. handed power back to the old guard, analysts offered this piece of advice for the as-yet-unnamed executive who will take over the flagging Internet division: Keep your mouth shut.

Any new executive hired to lead the faltering America Online unit must move quickly to address pressing problems such as slowing subscriber growth, a sluggish conversion to high-speed data connections and sagging Internet ad sales.

But over-promising gains to shareholders was as much the problem behind AOL as any of the other challenges that still face it, several analysts said Friday.

And Robert W. Pittman, who resigned under pressure Thursday as the parent company’s chief operating officer and head of AOL, was blamed for doing just that. Instead of results, investors got “quarter after quarter after quarter of having to lower expectations,” A.G. Edwards analyst Michael A. Kupinski said.

Although AOL Time Warner’s stock took another throttling Friday--as did the overall market--some analysts are predicting that the company will ride out its current woes.

Merrill Lynch’s Jessica Reif Cohen hailed the promotion of Time Inc. Chief Executive Don Logan to the new post of chairman of the Media and Communications Group, overseeing America Online, Time Inc., Time Warner Cable, HBO, Time Warner Book Group and the Interactive Video unit.

Under Logan, Cohen noted, Time Inc.’s magazine group has grown to 25% of the U.S. magazine market share and 41 consecutive quarters of growth in EBITDA, or earnings before interest, taxes, depreciation and amortization--a common earnings yardstick for media firms.

“Given the subscription- and advertising-based operating model, the AOL segment resembles the magazine business model,” Cohen said in a note to investors Friday, adding: “We believe Mr. Logan will be instrumental in leveraging traditional advertisers to the AOL platform.”

On Friday, AOL Time Warner’s shares fell to a 52-week low of $11.58, down 87 cents on the New York Stock Exchange. At that level, analysts said, the market is recognizing only the Time Warner entertainment assets and according zero value to the world’s biggest Internet service, with 34 million subscribers.

“People are throwing AOL out with the bath water,” Kupinski said.

That doesn’t mean that the Internet unit’s problems are trivial, however. “Pittman’s departure before a replacement was found underlines the tensions within the company and the complexity of turning around the online unit,” said First Albany analyst Youssef Squali.

He said it’s important for the company to line up cable TV partners offering additional high-speed connections for America Online’s customers by the end of this year.

Still, Squali rates AOL Time Warner stock a “strong buy,” arguing that the shares are “significantly undervalued.” Time Warner’s assets alone should yield a per-share price in the mid-teens, Squali said. And if investors valued America Online the same way they value no-frills Internet service provider EarthLink Inc.--at about eight times this year’s estimated EBITDA--AOL itself ought to be worth $3.60 a share, he said.

Wall Street research departments like AOL Time Warner a lot better than most investors do. Of 27 media analysts surveyed by earnings tracker Thomson First Call, 18 rated AOL Time Warner a “strong buy,” research director Charles Hill said. Put another way, the company scored a 1.5 on First Call’s 1-to-5 scale of analyst recommendations, while the average Standard & Poor’s 500 company rated a weaker 2.2, Hill said.

Kupinski and his AG Edwards colleagues won praise two years ago for spotting early signs of an advertising recession and warning investors away from ad-dependent firms such as AOL.

But today, he thinks advertising may be on the brink of a turnaround, although the rebound won’t show up soon in the online sector. Advertising and commerce revenues fell 31% at America Online in the first quarter compared with a year earlier, and Kupinski expects about a 40% drop for the second quarter, to be reported Wednesday.

The best time to own advertising companies is a little ahead of an economic upswing, and now may be the time for AOL, said Kupinski, who does not personally own AOL Time Warner shares.