Free AOL: Too little, too late?
Analysts debate whether giving away e-mail, other services will help the struggling Internet company.
By Paul R. La Monica, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- One of the worst kept secrets in the business world finally became official Wednesday: AOL is now going to offer many of its services for free to broadband customers.

The announcement was made as AOL's parent company, Time Warner, the world's largest media company, reported that it swung to a profit in the latest quarter. (Time Warner also owns CNNMoney.com.)

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Time Warner is going to give away many of its AOL services for free. But will that lead to a gain in sales and profits at AOL?
TECHNOLOGY

AOL said the free products would begin to be available in September. The company also said that people who've left AOL during the past two years will also be able to get their old e-mail addresses back for free.

Finally, AOL, contrary to some market rumors, also said that it's decided to continue offering dial-up access (for a monthly fee) to existing dial-up subscribers.

During a conference call to discuss AOL's new strategy late Wednesday morning, Time Warner chief operating officer Jeff Bewkes said Time Warner expects that the new plan will not have a negative impact on AOL's earnings this year and that operating profits for AOL should grow from 2007 through 2009.

AOL also plans to cut as much as $1 billion in costs next year, Bewkes said.

AOL CEO Jonathan Miller said on the call that most of the cuts will come from administrative and marketing expenses, since it's no longer going after dial-up subscribers. He did not say whether there would be layoffs at AOL.

The company also said it expects AOL sales to start growing again in 2009. The company will take a hit for the next few years as subscriber revenue further declines.

Too late to save AOL?

Will the new AOL strategy really lead to a rebound in sales and profits for the struggling unit, which was once the leading presence on the Internet? Some analysts were skeptical.

"It will be very difficult for AOL to reach out to old subscribers because they've turned to other services. What does AOL have to differentiate itself from Yahoo, for example? The difference is not that great," said Jennifer Simpson, a consumer technology analyst with the Yankee Group, an independent tech research firm based in Boston.

AOL, which merged with Time Warner (Charts) in 2001, has been blamed by many investors for Time Warner's sluggish stock performance in recent years.

Indeed, AOL still accounts for nearly 20 percent of Time Warner's overall sales and operating profits, so investors have been eager to see the unit's performance improve.

Executives at AOL are hoping the changes will reignite growth as AOL seeks to move from a subscription-based business to one that taps the rapid growth in online advertising. In particular, AOL expects to see its user base increase since anyone with a broadband connection will be able to sign up for the free AOL services.

"We'll now be able to maintain and deepen our relationships with many more members who are likely to migrate to broadband. Providing them with their familiar AOL software and e-mail for free, over any broadband connection, will be critical to our future success," Miller said in a statement.

Subscribers have left in droves during the past few years, tempted by faster broadband connections offered by cable and telephone firms as well as cheaper dial-up options.

AOL finished this year's second quarter with 17.7 million subscribers, down from 20.8 million a year ago. At the height of AOL's popularity in 2002, it had more than 35 million subscribers.

Another tech analyst said that AOL's shift is an end of an era.

"I feel that it's almost like a part of history is gone. This was a company that understood the market so well in the mid 1990s to provide the right service to the right people at the right time," said Allen Weiner, a research director with tech research firm Gartner Inc. "The company's inability to see the dramatic shift in the market makes me feel sad."

Many Time Warner investors have complained that AOL has stubbornly stuck to the strategy of charging subscribers for e-mail even though many competitors such as Google (Charts), Yahoo! (Charts) and Microsoft's (Charts) MSN unit have been offering e-mail for free.

Competition is fierce

To its credit, AOL has begun to offer more of its content, including news and streaming audio and video, for free on its site recently in a bid to boost traffic at its AOL.com site and boost ad revenue.

It's also planning to roll out a new video search tool later this week that will even include links to videos found at competitors such as Google's video service and the wildly popular YouTube.

With that in mind, one analyst thinks AOL may have a decent chance of wooing back former users.

"AOL's assumption is that users who go away as they upgrade to broadband go away because of price. I do think this is an appealing offer for loyal users who said I loved AOL but were not willing to pay a premium for it," said David Card, an analyst with Jupiter Research.

Still, despite these new initiatives, AOL only generated 22 percent of its sales from online advertising in the second quarter. But Bewkes maintained that AOL will be able to boost its traffic and online advertising revenue significantly over the next few years as the company de-emphasizes its dial-up business.

"This fully aligns us with the explosive growth in broadband," said Bewkes during the call.

Card added that the key for AOL will be to make sure that it can get its users to visit several of AOL's online properties. In addition to AOL.com, it also owns MapQuest and Moviefone, for example.

"AOL has some reason to be confident they have their act back together in advertising. As long as they can grow their audience they can be a player," he said.

AOL is taking other steps to bolster its presence online. Time Warner agreed to sell a 5 percent stake in AOL to Google earlier this year with the hopes that this partnership could lead to more revenue from search advertising, the area of online marketing that has seen the most explosive growth.

But AOL remains a distant fourth in search market share, behind Google, Yahoo! and MSN, according to research from online traffic research firms comScore Networks and Nielsen//Net Ratings.

And Weiner said that AOL risks losing market share to Ask.com, owned by Barry Diller's IAC/InterActive (Charts), and could fall to fifth in the search race.

Weiner added that he doesn't think it is clear that getting rid of fees for e-mail and other services will necessarily lead to increased users at AOL.com and other AOL properties, or that it will convince old AOL subscribers to re-sign with AOL.

"If I'm a broadband user I can already get anything I want from Google, Yahoo and Microsoft," he said.

Yankee Group's Simpson adds that AOL also faces formidable competition from social networking sites such as MySpace, which is owned by News Corp. (Charts)

So it remains to be seen whether or not the new AOL strategy will finally ease Wall Street's lingering fears about declining growth prospects at AOL.

"Time Warner is holding its breath to see how the investment community reacts to the AOL plan," Weiner said. Investors seem to like what they see for the short-term at least; shares of Time Warner rose about 3 percent Wednesday.

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Analysts quoted in this story do not own shares of Time Warner and their firms have no investment banking relationships with the company.

The reporter of this story owns shares of Time Warner through his company's 401(k) plan.  Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.