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AOL slims to grow

Imminent layoffs--of more than 700 workers--may help America Online grow as subscriptions deline.

Fat-trimming has helped ailing America Online set a course to recovery--but questions persist about whether that will be enough for the Internet veteran to reclaim its former glory.

Early next week, AOL is expected to undergo another painful round of layoffs, ranging north of 700 workers, according to sources familiar with the plans. Most of these layoffs will hit AOL's 5,000-employee Dulles, Va., headquarters, with operations such as broadband, technology development and marketing hit particularly hard, other sources close to the company said.

Analysts said the tough medicine will further boost AOL's operating income, which has soared even as millions of subscribers turn their backs on the company's dial-up service in favor of faster broadband connections. Customers are taking their money to cable and DSL providers at the expense of the dial-up giant. AOL executives have been looking at ways to deal with a shift that shows no sign of stopping.

AOL has "been good at cutting back both in network costs and other costs which include personnel," said Rob Sanderson, an equity analyst at American Technology Research. "But I think this business model does not afford revenue growth anytime soon."

News.context

What's new:
AOL is laying off more than 700 workers next week in an effort to maintain profits as it loses dial-up customers to its broadband rivals.

Bottom line:
A tighter belt and a push to become a major ad-driven Internet portal might be AOL's only hope as its dial-up business dies a slow death.

More stories on AOL

Next week's layoffs highlight another crossroads for AOL since its business began crumbling two years ago. The Time Warner division is diverting more resources toward building out its long-underserved AOL.com home page to compete with Yahoo, Google and Microsoft's MSN for a greater share of online advertising dollars. While AOL will continue selling subscriptions to its online service, its fabled walled garden will become more porous as previously exclusive programming finds its way onto the Web for people who don?t pay for an AOL subscription.

AOL recently created a new business unit called "audience," headed by Ted Leonsis, the former president of AOL who, sidelined during the boom years, has resurfaced as a leader in its turnaround. Leonsis' unit will try to draw more visitors to its AOL.com home page by offering more free content and services. It also hopes to drive larger audiences to its other properties such as Mapquest, AOL Instant Messenger and a newly released upgrade of its long-suffering Netscape browser.

AOL has taken numerous stabs at the free Web portal business in the past, primarily using Netscape.com as its guinea pig. But these efforts went nowhere, despite attempts to use Netscape as a distribution site for Time Warner content and to gear the site toward small-business owners.


Analysts said AOL has no choice but to chase growing Web advertising dollars to offset inevitable defections from its dial-up service.

"Back then, they were probably half-baked Web initiatives, but now there's a sense of urgency and realization that they can't stake their future on dial-up," said Mark May, an analyst at Kaufman Bros. "I'm not sure that mindset was there."

Keeping expenses in line
Tough medicine and the rebounding online advertising market have fueled profit growth at AOL, giving much-needed breathing room for the company as it looks for a way out of its dead-end dial-up business. Revenue has remained flat at about $8 billion a year since 2002, but operating income has jumped following successive staff cuts that last year showed some 500 employees the door, including 450 just weeks before the holiday season.


Despite losing millions of subscribers in the United States, AOL is on track to earn close to $1.9 billion in operating income before interest, taxes, depreciation and amortization (OIBITDA), an industry benchmark of profitability.

AOL's tenacious earnings power has for now largely squelched talk of a possible spinoff or sale of the division. Suitors have approached Time Warner to propose acquiring AOL, according to sources close to the company, but the media giant has not budged, opting instead to give AOL a chance to turn itself around.

Cost-cutting is a big part of the equation. In addition to laying off workers, the company has pared back network costs significantly, boosting margins. That could offer a silver lining for the company even as it loses its core base of dial-up customers--a trend that many believe is unstoppable.

Counterintuitively, AOL's subscriber revenue has climbed even as the total number of its U.S. dial-up subscribers plunged from 26.4 million in the third quarter of 2002 to 22.4 million in the same period this year. AOL says that many of the millions of people leaving the service weren't paying for it anyway, thanks to aggressive giveaway programs, since curtailed, that had aimed to fuel subscriber growth. In addition, losses in the United States have been offset by gains in Europe.

To address subscriber defections, AOL introduced a $9.95 plan for those leaving for discount ISPs such as NetZero. AOL also has begun offering a $14.95 a month "bring your own access" plan aimed at broadband users featuring video, music and other exclusive content. The company says 1.8 million people have signed up for the service, but analysts said the jury is still out on its success.

"If we continue to see broadband subscriber additions offsetting the majority of dial-up losses, then I think AOL will be fine," said American Technology Research's Sanderson. "But if we see broadband subscribers really drop next year, then we will be more concerned."

Will online advertising be enough?
AOL's online advertising performance shows some glimmer of hope. Despite watching ad revenue fall from $1.3 billion in 2002 to $787 million in 2003, AOL has witnessed growth in the business over the past three quarters. At its current rate, AOL is on track to generate more than $900 million in ad revenue this year.


Commercial search has become a lifeboat for the company, much as it did for Yahoo three years ago, when receding online advertising dollars nearly toppled the company. AOL has a deal to host paid search links supplied by Google; the search giant pays AOL a fee every time someone clicks on a sponsored link. That arrangement has fueled most of AOL's advertising growth, supplying revenue averaging around $75 million a quarter this year.

It's unclear whether AOL's advertising gains will be enough to offset the impact of its subscriber declines, however.

Next week's layoffs are expected to be nearly double those announced last year, and further pink slips may be necessary to maintain AOL's strong cash generation. The division has promised double-digit yearly OIBITDA growth to Wall Street, which would mean more blood if it fails to capture advertising dollars.

Paul Kim, an equity analyst at Tradition-Asiel Securities, said AOL is adept at trimming costs to maintain profit.

"They are relatively confident that in the next one to three years, they have such control of their cost structure that if revenue goes down, they can (still) hit double-digit growth," he said.