Free AOL for Broadband Subs

Time Warner pulled the cover off the worst-kept secret in the online industry Wednesday, mapping out in a one-hour presentation a new strategy for its struggling AOL unit: offering the service free-of-charge to broadband subscribers in an effort to attract greater advertising revenue.

The announcement came as no surprise. But although earlier reports speculated that AOL parent Time Warner was prepared to take a big earnings hit as AOL narrowband users defected, Time Warner management actually believes earnings will increase as a result of the new strategy.

Driving that profitability will be a $1 billion reduction in operating costs by the end of next year, mainly by slashing subscriber-acquisition-marketing costs.

AOL will provide free software to broadband customers, including AOL e-mail; instant messaging; a local phone number with unlimited incoming calls; social-networking applications; and safety and security features, such as parental controls. Former AOL members who have left the service within the past two years will also be able to reactivate their old AOL screen names.

The restructuring has been expected for months as AOL’s once-industry-leading subscriber base dwindled. In the second quarter ended June 30, AOL said it lost about 1 million subscribers, ending the period with about 17.7 million customers. AOL had about 26.5 million subscribers in 2002.

On a conference call with analysts, Time Warner chief operating officer Jeff Bewkes said that while AOL will be giving up some subscription revenue, it will more than make up for that deficit with increased advertising sales.

AOL has been growing its ad base. For the second quarter, total advertising revenue was up 40% to $449 million. While that was a healthy increase, it still lags far behind competitors like Google, which had total ad revenue of $2.4 billion in the second quarter.

AOL’s advertising revenue has been on the upswing since the fourth quarter, and that success -- coupled with an 80% increase in its revenue-per-thousand-page views in the past two years, from $3.19 to $5.71 -- helped to fuel the increased optimism.

“That’s why the time is right for us to move to this next strategic phase now,” Bewkes said, adding that the changes will have no effect on AOL’s profitability.

“Acquiring narrowband subscribers is becoming unprofitable, so we made the decision to stop acquiring them,” Bewkes said. “That one move alone would increase earnings this year.”

While it did not give any specific figures, AOL expects adjusted operating income before depreciation and amortization (AOIBDA, a measure of cash flow) to increase each year from 2007-09 (it should remain unchanged in 2006) and advertising revenue to grow at or above market rates in the same time frame. Revenue should increase beginning in 2009.

AOL will continue to provide premium access – including 50 gigabytes of storage and unlimited premium customer service -- for $25.95 per month. A lower-cost plan is available for $9.95, including unlimited dial-up access, the AOL client software, live customer service and content.