The WSJ has another excellent article detailing the projected financial impact of AOL’s plan to eliminate subscription fees for users who already have online access. (Time Warner has clearly decided to pursue an informal “comments welcome” period before the plan is voted on, perhaps so the Board doesn’t approve it and then get laughed out of town).
According to the article, AOL expects to remain profitable through a three-year transition period, but lose an estimated $2.7 billion in revenue and about $1 billion in operating profit. To hit these numbers, the company will have to continue growing its advertising business 25%-30% per year AND crank up the advertising operating profit from 17% to 42%. This latter assumption depends on the online advertising market and AOL’s traffic remaining strong (neither of which is a given).
The company’s biggest challenge, which the article does not mention, will be to ensure that subscribers who drop their subscriptions but continue to use the service generate as many page views as subscribers who keep the service. Right now, the big flaw in AOL’s portal model is that subscribers generate the vast majority of the company’s page views (mostly through email usage). If subscribers who quit the service generate fewer pageviews than they did as subscribers, then AOL will have lost two ways, and the free-subscription gambit will have failed.
The article also does not explain another mysterious assumption of the plan: How AOL expects to boost the profit margin in its remaining subscription business from an estimated 38% today to some 53% in 2009. Per the article, the subscription business currently generates $4.2 billion in revenue and $1.6 billion in operating profit (38% margin). In 2009, the article reports, the company expects revenue of $1.5 billion and operating profit of $800 million (53%). Given that the main driver of increased subscription profitability–declines in the cost of telecom services–is flattening, how is the company going to increase the subscription operating profit so much while cutting its scale by almost two thirds?
AOL apparently expects the plan to knock its overall operating profit down into the “mid-single digits.” Given the apparently heroic assumptions above, however, shareholders would probably be wise to brace for losses. The company is probably still smart to pursue the plan, but shareholders are not likely to get off this easy.
A perceptive reader pointed out that AOL has another big expense it can slash if it waves the white flag on the subscription business–marketing. Assuming the company is still spending a big pot of money preaching to deaf ears, this would instantly boost the margins in the subscription business well above the 38% reported by the WSJ. If the company is still spending, say, $1 billion, and is able to cut this number to zero (unlikely, given that the company will now have to establish a different brand identity, but for the sake of argument…), the profit margin in the subscription business would leap to 62%, which would make a 53% margin on a smaller business seem far more feasible.