AOL Slows Decline But Still Faces Challenges

NEW YORK -- Although AOL managed to slow down its decline by boosting its quest for advertising dollars, the disclosure that ad growth has cooled suggests its road back to prosperity will be rough.

AOL had its weakest quarter of advertising growth since the company announced a year ago it would try to drive traffic to its ad-supported Web sites by giving away AOL.com e-mail accounts, software and other features once reserved for paying customers.

AOL, Time Warner Inc.'s online division, had $522 million in ad revenues in the quarter ending June 30, a 16 percent increase from $449 million a year earlier. By contrast, ad revenues grew 40 percent or more in each of the previous four quarters.

And ad growth remained too meager to fully offset declines in subscription revenue, which continued to plummet, as expected, following last August's strategy shift. AOL had 10.9 million paying U.S. subscribers for Internet access as of June 30, a 60 percent drop from its peak of 26.7 million in September 2002.

Overall revenues at AOL dropped 38 percent to $1.3 billion. AOL now accounts for 11 percent of Time Warner's revenues, about half of the 20 percent it had contributed until last June.

Story Continues Below

In a conference call Wednesday, Time Warner Chairman and CEO Dick Parsons said the company no longer expects AOL's ad sales to meet or exceed the growth rate seen by the broader U.S. Internet industry this year. Parsons said Time Warner was revising its outlook so AOL managers can make decisions based on long-term needs, not short-term targets.

Parsons attributed some of the slowdown to recent redesigns in AOL's Web sites, including tools for e-mail and search.

"Users usually need a little time to become accustomed to the redesigned pages, and advertisers naturally want to see how the new program performs before reinvesting significantly," he said. "Improvements like these to AOL's programs and products, which we're confident will yield long-term benefits, will come with some disruptions."

Despite the setback, AOL succeeded in reducing its dependency on subscription dollars, which now account for 55 percent of the unit's revenues, compared with 76 percent a year ago.

Over the past 12 months, AOL's ad revenues grew 37 percent _ higher than Yahoo Inc.'s 11 percent and Microsoft Corp.'s 21 percent, but less than Google Inc.'s 64 percent, according to an Associated Press analysis of quarterly earning reports.

According to comScore Media Metrix, AOL's U.S. audience grew about 1 percent to 114 million unique visitors in June. But that's less than the 3 percent growth seen by both Yahoo and Microsoft's MSN and Live properties and the 18 percent at Google after excluding YouTube and other recent acquisitions by the search engine leader.

AOL also trails all but Yahoo in page view growth _ and Yahoo's decline is partly attributable to its increased use of Ajax, which delivers updates to users without requiring a new page. In search, AOL is behind those three as well.

But AOL is tops under Nielsen/NetRating's new measure of total minutes. Americans spent 25 billion minutes in June using AOL properties, including MapQuest, Moviefone and its popular AIM instant-messaging service. Yahoo was the closest rival, with 20 billion minutes.

AOL's agreement to buy behavioral-targeting ad firm Tacoda Inc. should result in more dollars per ad sold. David Hallerman, a senior analyst at the research group eMarketer, said the purchase also extends AOL's reach to third-party sites that already have deals with Tacoda but not AOL.

Parsons told financial analysts that ad dollars have been shifting toward third-party ad networks, putting pressure on AOL's own sites. But AOL should be able to weather that, he said, with holdings like advertising.com, which sells ads for both AOL and outside sites. The company said advertising on such third-party sites rose 32 percent.

AOL's rivals are also hoping to further extend their ad reach beyond their own sites. Google plans to buy DoubleClick Inc., while Yahoo acquired Right Media Inc. and Microsoft has announced it's buying aQuantive Inc.

To boost traffic, AOL has more work to do.

David Card, a senior analyst at Jupiter Research, said AOL has done relatively well but is surprisingly behind in user-generated media and social networking, which the company pioneered in the 1990s with its popular chat rooms and buddy lists for instant messaging.

"Clearly they are not MySpace and Facebook," Card said, referring to the two leading online hangouts.

Rob Enderle, principal analyst with the Enderle Group, said AOL's strategy shift was crucial and has kept the company in business, but unless it becomes more competitive, "this property will be without value by this time next year."

The first year was about "patching the holes in the boat to make sure it doesn't sink," Enderle said. "Now they have to figure out how to fire up the boilers to get it moving again."

Editor's note:
Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.
12 Ways to Recession Proof Your Portfolio
Learn the Money-Making Secrets of the World`s Four Most Successful Investors