AOL stands by profit forecast despite slump

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The spotlight is on AOL Time Warner this week as it reports its first earnings since the merger of America Online and Time Warner was finalized.

Wall Street analysts expect the world's largest media and Internet service company to deliver on its promises when results are released April 18, thanks largely to intensive belt-tightening measures. Despite a tough quarter, the company has stood by its optimistic forecasts. Management claims synergy among its online, publishing, broadcast and entertainment units is already apparent, and analysts generally agree. But some worry the company may have set the bar too high for the tough year ahead.

The company is already faced with a worse-than-expected economic slowdown, which has affected advertising revenues. The ad slump comes as it must overcome integration challenges on a grand scale by merging two huge corporate entities. Even as those two sets of pressures drive the first half of the year, there is a wild card for the second half-likely actors' and writers' strikes that would slam the film and TV industries.

A report from Credit Suisse First Boston analyst Jamie Kiggen noted it will be important to see if the earnings growth in the second half comes more from revenue growth or cost savings. AOL Time Warner announced a restructuring in January, two weeks after the deal closed, which included 2,400 layoffs and the closing of its Warner Brothers Store retail chain. Additional cuts are expected, including an aggressive buyout plan at publishing division Time Inc.

"The real challenge for AOL is less in the first half of this year ... but the ramp in [the second half]," Mr. Kiggen said. He noted revenue is projected to grow at 8% in the first quarter and 12% in the second, but the growth targets grow significantly, to 14% in the third quarter and 20% in the fourth.

"This is a business that is going through a classic merger in an environment where the advertising market is weak," said Christopher Dixon, advertising analyst at UBS Warburg.

Mr. Dixon has rated the stock a strong buy and believes AOL Time Warner will meet its targets, as do other analysts. He projects the company will report pro-forma revenue-split equally among advertising, subscription and content revenue-of $9.9 billion for the first quarter, up from $8.9 billion in 2000, and earnings of $2.6 billion, up from $2.1 billion. America Online and the cable business will lead the way, driven more by subscription than advertising growth. The TV, film and music divisions will be flat, he forecasts. The publishing unit will show increased revenue, but only due to the acquisition of Times Mirror Magazines.

Most analysts agree the company can meet its 2001 targets of $40 billion in revenue and $11 billion in earnings, but doubt that will be achieved without a hike in America Online's subscription prices. According to Zacks Investment Research, AOL Time Warner's stock is rated as a "buy" or "strong buy" by 33 out of 36 analysts who cover it; three rate it a "hold."

The company has begun cross-selling its various platforms, such as online, cable and broadcast TV and magazines. Speaking at a conference sponsored by Goldman Sachs April 6, Chief Operating Officer Robert Pittman said the company is using its magazines to drive subscriptions to AOL, and vice versa. AOL said it is generating 100,000 subscriptions per month to Time Inc. titles. But many of the division's 50-plus magazines have circulations over 500,000. They have also been hard hit by circulation problems, including the collapse of sweepstakes marketer American Family Enterprises, so it's unclear how much of an impact the AOL-driven subscriptions will have on overall results.

AOL is well positioned against other Internet service providers thanks to its ability to sell advertising across several platforms and to leverage Time Warner's relationships with traditional advertisers and ad agencies, noted a report from Deutsche Bank Alex. Brown analyst Andrea Williams Rice. AOL has established a reputation of never missing earnings targets, which puts pressure on the Time Warner divisions to perform.

AOL Time Warner's 2001 forecast calls for revenue growth at a 12% to 15% rate, with advertising revenue growing 18% to 22%, subscription revenue growing at 12% to 14% and content revenue up 6% to 8%, according to Mr. Pittman's presentation at Goldman Sachs.

Time Warner's and AOL's subscriber base is "recession resistant," Mr. Pittman insisted. In a shrinking economy, cash-strapped

consumers will cut out-of-home activities first, not at-home entertainment such as Internet and cable service, he said.

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