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America Online born again

The online giant is charging ahead with an Internet TV strategy, and its stock is fighting its way into the record books again.

America Online has come a long way in a relatively short time.

Less than two years ago, the company lost hundreds of millions of dollars, suffered a 19-hour outage that was one of the worst in online history, and faced a threatened lawsuit from about half of the states' attorneys general for its spotty service record. The problems made front-page headlines and forced chief executive Steve Case to apologize in national television ads.

Today, the company is charging ahead with a strategy to put its service on television sets, and its stock is soaring into record territory again. The boost comes despite AOL shaking up the industry earlier this year with plans to raise its monthly rates by 10 percent.

All of which begs the question: What has AOL been doing right?

For one thing, the company has beefed up its senior management, recruiting executives such as MTV's Bob Pittman, and has improved its service. It has also aggressively cut costs, allowing the company to return to profitability.

The general run-up in Internet stocks hasn't hurt, either. Internet service providers and free Web-based online services have been among the high-flying gainers of 1998.

AOL shares have jumped more than 100 percent since the year began; EarthLink, which dropped about 5 percent in trading this morning, is still up more than 150 percent this year; and PSINet is up more than 140 percent. The free counterparts to AOL, such as Yahoo and Excite, also have seen their stock prices take great strides this year.

The jump in AOL's stock price today follows yesterday's report of earnings that blew away Wall Street's estimates, and the company's announcement that it is buying Web-enhanced television provider NetChannel, a move that is seen as a foot in the door as far as allowing AOL users to access its service through their television sets.

Jill Frankle, an analyst at International Data Corporation, said AOL needed to develop its strategy on how to tackle the Internet set-top or interactive television market. She pointed out that cable companies are rolling out digital set-top boxes, and AOL now may have a service for these technologies.

The NetChannel acquisition further extends AOL?s dominance into potential interactive TV and broadband connectivity markets, Shaun Andrikopoulos, an analyst at BT Alex. Brown, said in a report.

"They need to have a clear-cut strategy to compete against those folks and non-PC devices," Frankle said. [They are taking a step] by playing this acquisition of NetChannel off as 'AOL Anywhere.' They don't have the service, per se, but they now have the resources, the talent, and engineers to have the next step in offering AOL on non-PC devices."

Building out the way in which consumers can access AOL's service is one way to gain market reach. AOL's traditional service on the Internet has been facing competition from a slew of companies that are giving similar services away for free, such as Excite and Netscape.

Those kind of companies in particular are quite possibly AOL's biggest threat, said Frankle, who noted that AOL also is going to face stiff competition from Microsoft's work-in-progress: a home page code-named Microsoft Start, which will incorporate a search engine and its recently acquired free email service, Hotmail.

"An increasing number of [Internet users] are looking to Yahoo for good service and brand name," Frankle said. "This is head-to-head competition."

Another factor AOL must consider: Many people get Internet access through bare-bones ISPs or at work instead of coming online directly through AOL.

The company is trying to combat this by building out, a free Web-based service. It is hoping for a summer release of a version of the service that could include features such as "My News," which offers personalized news and information. AOL already offers a beta version of "AOL Netmail," which lets its users access their email via the Web.

However, free email, such as Hotmail, could undermine AOL's proprietary online service, analysts said--a key difference between AOL's free Web-based service efforts and those of the Internet directories.

Those services may not be as old as AOL, but their business strategies may be just as successful.

AOL's year-over-year advertising and commerce revenue growth rate is comparable to Yahoo's and Excite's growth rates. AOL, Yahoo, and Excite produced year-over-year growth rates for advertising and commerce revenues of 210 percent, 200 percent, and 206 percent, respectively, according to Merrill Lynch.

With those companies offering their services for free, people may be enticed to try them out, especially since AOL recently upped its prices.

Another big risk for AOL is execution in a "hyper-growth environment," as well as potential pricing pressure from weaker Internet players as they partner with access providers, said Andrikopoulos.

The AOL price hike took effect April 1, but analysts are waiting until the end of the current quarter to see if the company is hurt by the rate increase. AOL upped its monthly fee to $21.95 from $19.95.

"The growth has not slowed yet," Frankle said, noting that AOL also showed strong international growth in its earnings announcement yesterday. The company's flagship service signed up 1.15 million new members, bringing the total number of subscribers by the end of the quarter to 11.9 million.

AOL chief financial officer Lennert Leader said during a conference call yesterday that this latest quarter's increase in new customers marked the company's "third biggest quarter in membership growth."

But all that growth--AOL topped 12 million members worldwide in April--has caused a lot of headaches for the giant online service, as well as for its users.

AOL, which has been criticized before for poor system access, has continued adding modems to its infrastructure in an attempt to ward off any future problems. As part of its efforts to expand its network to meet new demand, it added more than 25,000 modems in each month during the quarter. It also continued to roll out its next-generation 4.0 software.

Instead of allowing everyone download the software at once, something that could overwhelm the system, the company has been rolling it out and marketing it incrementally. At the end of the quarter, about 1.2 million member were using the software, the company said.

The online service initially was plagued with access problems when it went to unlimited pricing last December. About a year ago, AOL had the highest call failure rate of 14 major Internet service providers, according to a study released at the time.

As a result of the company's operating results, Merrill Lynch revised its earnings estimates upward today for fiscal year 1998 and 1999. The revised fiscal 1998 earnings estimate now stands at $147.8 million, or 57 cents a share, and 1999 earnings now are estimated to be $237.8 million, or 90 cents per share. The firm also increased its price objective to $120 per share.

BT Alex. Brown also upped its 12-month to 18-month price target of $122, and reiterated its "strong buy" rating.