America Online chief to step down

update Barry Schuler, chief executive of AOL Time Warner's America Online division, will relinquish his post and lead a newly formed division that aims to develop digital services for the media giant.

Gartner analyst Robert Batchelder says that to succeed, AOL Time Warner and other big media companies must confront the Internet dilemma. see commentary

Bob Pittman, co-chief operating officer of AOL Time Warner, will assume full responsibility of the AOL division. Pittman is also set to become the sole COO of AOL Time Warner when CEO Gerald Levin steps down in May.

"Nobody understands AOL's operations and potential better than Bob Pittman, and no one is better qualified to manage this business," AOL Time Warner co-COO Richard Parsons, who will replace Levin as CEO, said in a statement. "Bob is taking on this role at a time of both opportunity and challenge."

Once billed as the "jewel in the crown" of AOL Time Warner, the AOL division has come under tremendous scrutiny from Wall Street for anticipated flat revenue growth. Analysts expect the division to be hit hard in the coming year by the effects of the online advertising collapse and its failure to renew several lucrative multiyear advertising deals.

As a whole, AOL Time Warner is at a crossroads after only 15 months as a combined company. In the past year, the company missed its ambitious financial goals and its CEO abruptly decided to step down.

Tuesday's announcement is yet another setback for the AOL side of the combined company. Although the Internet giant acquired media titan Time Warner, its strength has waned with the dot-com decline. Outgoing CEO Levin's decision to hand the mantle to a Time Warner executive, despite predictions that former AOL executive Pittman would ascend to the throne, emphasized the Internet side's weakness.

With Schuler's shift, Pittman returns to familiar territory. He previously served as the president and COO of AOL and was largely responsible for transforming the company from a congested second-tier Internet service provider into an online powerhouse capable of acquiring Time Warner.

But the post-merger AOL that Pittman inherits faces tremendous challenges. The biggest issues he needs to address are the division's diminishing advertising revenue and its slow growth in adding cable broadband subscriptions. Furthermore, Pittman will need to figure out AOL's role in the company now that subscriber growth is threatened by market saturation and heightened competition from Microsoft.

"The story about ever-spiraling subscriber growth (reaching) to the moon, that doesn't play anymore," said Jordan Rohan, an analyst at SoundView Technology Group. "People focus on the value per subscriber."

Turmoil in Oz
Fixing the advertising side will be especially difficult. AOL Time Warner executives have said they do not expect revenue growth for the AOL division in 2002. The point was underscored when the AOL division said its fourth-quarter 2001 earnings declined 7 percent to $637 million from the previous year.

Even that figure is seen as optimistic, given that AOL accounted for $138 million of advertising from other AOL Time Warner units. Without receiving intercompany dollars, advertising actually decreased 27 percent for the division.

Backward glance Jan. 11, 2001: America Online and Time Warner complete their merger for about $106 billion. Jan. 24: AOL Time Warner lays off 2,400 employees. Jan. 31: In its first earnings report as a combined company, AOL Time Warner announces quarterly revenue of $10.2 billion and earnings, excluding charges, of $2.4 billion. March 23: Richard Bressler, head of investments for AOL Time Warner and formerly Time Warner's chief financial officer, says he will leave the company. April 18: The company reports first-quarter revenue of $9.1 billion and earnings before charges of $2.1 billion. May 22: The AOL service raises its monthly rates from $21.95 to $23.90. June 16: Talks dissolve between AOL Time Warner and Microsoft over the bundling of AOL software within Windows XP. July 18: Revenue for the second quarter misses estimates, coming in at $9.2 billion; earnings, excluding charges, reach $2.5 billion. Oct. 16: AOL unveils the latest version of its Internet software, AOL 7.0. Oct. 17: Third-quarter revenue comes in at $9.3 billion; earnings before charges total $2.5 billion. Nov. 1: AOL Time Warner assigns former Chief Financial Officer J. Michael Kelly to the newly created position of chief operating officer of the AOL unit. Dec. 5: CEO Gerald Levin announces he will retire in May 2002; co-COO Richard Parsons is chosen to replace him. Jan. 7, 2002: AOL Time Warner warns that it will miss 2001 revenue projections by about $2 billion and earnings before charges by about $1 billion. Jan. 30: The company reports fourth-quarter revenue of $10.6 billion and quarterly earnings, excluding charges, of $2.8 billion. Total 2001 revenue comes in at $38.2 billion, with earnings before charges at $9.9 billion. March 12: AOL surpasses 34 million subscribers worldwide but in more than twice the amount of time it took to add the previous million. March 14: The AOL division tests technology developed by Netscape Communications in its latest software, fueling speculation that it may replace Microsoft's Internet Explorer as its default Web browser. Source: AOL Time Warner and CNET News.com

The merger between AOL and Time Warner was billed as the creation of the world's first converged media company. The marriage would intertwine AOL's Internet expertise with Time Warner's publishing, film, music and cable empire, while using all of the company's assets to create new interactive businesses.

In reality, the merger has underdelivered on most of its promises, disappointing Wall Street with lackluster financial results and so far producing little in the way of convincing "convergence" businesses.

That the deal was completed at all increasingly appears to have been a fluke of timing made possible by the momentary cresting of the Internet wave. When it was announced on Jan. 10, 2000, AOL was at the peak of a stunning run-up in its stock that allowed it to give up less than half of its shares to take control of the world's largest media company.

The deal was first valued at $165 billion, creating a company with a combined market cap of more than $350 billion.

To say the acquisition has declined significantly in value since the announcement would be an understatement. Since that fateful day in January 2000, some $250 billion in shareholder value has evaporated amid a widespread market decline. While AOL Time Warner has not suffered alone, few other companies come close to sharing the intensity of its pain. The company was forced to take a record $54 billion noncash charge relating to the merger in the first quarter of 2002, in compliance with new accounting rules.

AOL Time Warner's troubles have also forced a hard reassessment of what was originally viewed as the company's chief growth engine, AOL. Questions linger about the health of the online access business in the face of a long list of woes, including lagging sign-up rates for subscriptions of its dial-up service, reliance on free trials to inflate its membership base, and slower-than-expected sales of its high-speed service.

"They haven't been able to execute on all the fronts they had hoped to post-merger, especially in broadband and on the international front," said Lisa Gurry, product manager for Microsoft's rival Internet service, MSN. "We think the competitive pressure they're feeling from MSN is certainly playing a role and they're looking to make changes in their organization."

AOL remains the undisputed leading Internet access service with 34 million subscribers as of last month. However, it took AOL 74 days to add its most recent million members, compared to just 35 days for the previous million.

Furthermore, analysts are beginning to question the efficacy of AOL's liberal free trial offerings. AOL continues to tout its enormous subscriber base as its greatest asset, eagerly pointing out that MSN, its closest rival, counts just 7 million subscribers. But analysts now appear less concerned with raw subscriber numbers than with how much money each member adds to the company's coffers.

Here the news is not good. The gap between AOL's published price and what it actually collects per subscriber has widened considerably in the past year. Last year, the company increased its monthly charge to $23.90 from $21.95. But the average monthly subscription revenue per member has remained where it was before, between $17 and $18, according to Wall Street analysts.

AOL executives attribute the discrepancy to distribution deals with PC manufacturers, which offer substantial free trial periods. In addition, the company argues that even the freeloaders bring in revenue in the form of higher advertising fees and e-commerce transactions.

Nevertheless, one of the cornerstones of AOL Time Warner's business remains subscription revenue, which executives consider resistant to economic recession. Given the number of powerful subscription businesses in AOL Time Warner's arsenal, such as AOL and Time Warner Cable, executives still believe in the potential of these businesses.

In a speech last December, AOL Time Warner's Pittman pinned the future of the media giant on AOL's broadband service, which would pipe the company's content and services into households. Pittman said the broadband pipeline would allow the company to charge about $159 a month per household for a package of services. He added that combining interactive services through Time Warner Cable could increase revenue to $230 a month per household.

Geek in CEO's clothing
Given AOL's troubles and goals, Schuler's reappointment is not surprising. Many agree that the division needs a greater bottom-line focus, which is not Schuler's strength as an executive. The former CEO has been known more for his product development savvy than for a hard-driving, results-oriented nature such as the one Pittman personifies.

Schuler joined AOL in 1995 when his software company, Medior, was acquired by the then-struggling online service. At that time, during Steve Case's tenure as CEO, AOL acquired Schuler's company after Medior was hired to redesign AOL's interface. Case is now chairman of AOL Time Warner.

Former and current AOL employees agree that Schuler is at his best when thinking about how AOL's services fit into the newest wave of gadgets and devices. But this was not the pedigree required to resolve the division's ongoing problems. Sources close to AOL Time Warner said last year's reappointment of Chief Financial Officer J. Michael Kelly as AOL's COO was a move to infuse a numbers-focused executive to compliment Schuler.

Schuler's new role will largely be to oversee the company's entry into home networking, digital music and other interactive products for future growth.