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THE DAY AHEAD: Mileposts for AOL Time Warner

COMMENTARY -- With the AOL Time Warner merger about to finally close, investors should put aside all the descriptions of the entertainment giant -- colossus, media empire, Internet gatekeeper -- and focus on how shares will trade.

Make no mistake about it -- AOL Time Warner (NYSE: AOL, TWX) isn't the old AOL. Would AOL ever issue a profit warning and partially blame that horrid movie "Little Nicky" for its woes?

This new media titan, which has been dropped from the Dow Jones Internet index, will be slower and will put up growth numbers that will at times be mediocre. Investors know the potential pain of synergy, and that's why a lot of folks sat on the sidelines for the last year.

Now that the AOL Time Warner merger has received clearance from the Federal Trade Commission and is likely to be approved by the Federal Communications Commission any day now, it's time to examine what could move the stock.

The conventional wisdom used to be that the AOL and Time Warner merger would close and shares would move on synergy promises.

Don't count on it.

Analysts are doing their best to cheer for AOL Time Warner, but the message isn't getting through to investors. "AOL remains our favorite large cap stock," said DB Alex Brown analyst Andrea Williams. "We believe there is little downside at these levels and significant upside over the next 12 months."

Williams, like other analysts, makes a value argument for AOL shares. Relative to other media giants, AOL Time Warner shares almost look cheap. Williams has a price target of $60.

Here are some upcoming mileposts to watch:

The analyst meeting

AOL Time Warner's analyst meeting could change investors' perceptions. On Jan. 31, AOL Time Warner is expected to have a coming out party for Wall Street analysts.

AOL Time Warner's analyst meeting is most likely the start of a news barrage for the company.

The big question is whether AOL Time Warner will hit its previous guidance. Management has restated its initial projections, but some folks doubt the company can deliver.

AOL Time Warner management originally projected $40 billion in revenue in 2001, growing at a 12 percent to 15 percent clip. The company projected $10 billion in free cash flow (free cash flow is defined as EBITDA minus capital expenditures) in 2001, including $1 billion in "synergies." EBITDA (earnings minus all the bad stuff) is expected to grow 30 percent in the first year and 25 percent after that.

However, Time Warner recently said its earnings growth would be slower than expected. At a media investment conference in New York last month, the tone was glum for traditional media spending.

Advertising is among the first expenses to be cut in a slowing economy. Meanwhile, online advertising worries hover over AOL. Sure, AOL dominates and is insulated from the dot-com meltdown, but no one is completely immune.

Tom Wolzien, an analyst at Bernstein, said 42 percent of the combined companies' 2000 revenue came from subscriber fees (cable systems, cable networks, magazines and AOL), while 21 percent of revenue is from advertising. Six percent of the total combined revenue is AOL's online advertising activities.

AOL's December quarter

While we know Time Warner's December quarter is so-so, analysts contend AOL's quarter will be on the mark.

Part of AOL's success is that it's a titan and a must-buy in the advertising world. AOL is also gaining shares on rivals, especially as free Internet service providers struggle, analysts said.

Youssef H. Squali, an analyst with ING Barings, expects AOL to report ad/e-commerce sales of $730 million on revenue of $2.14 billion, in line with consensus. Earnings are expected to be a penny ahead of consensus estimates of 15 cents a share.

Subscriber growth is expected to be strong, up 27 percent from a year ago. Revenue per subscriber is expected to be at $19.28, indicating nearly all customers are paying full price.

On the conference call look for hints of future fee hikes for AOL. Some analysts have speculated that AOL will raise its subscriber fee some time in 2001 from the current $21.95 a month.

Proof of synergies

"We believe the combination will create an unparalleled powerhouse in content, distribution and direct merchandising," said Arthur Newman, an analyst with ABN Amro.

And he isn't alone.

In the long run, it's hard to argue with that assessment. AOL Time Warner will have its paws in everything, but the real key will be how the companies cross-sell services. There has been some progress -- an AOL disk with Sports Illustrated -- but there's a lot more to do.

It'll take a few quarters to see the real cost savings. AOL will have to Web-enable Time Warner's traditional businesses. Meanwhile, there's a host of territorial issues to be worked out among management. Integrating the two companies and their cultures will be a tough job that may take years to complete. Will investors want to wait that long?TDAIN

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