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Launch-Fee News Suprises

Cable analysts have been poring over the details of how AOL Time Warner Inc. has been booking launch fees from cable networks as advertising revenue — a practice described as quite uncommon within the cable industry.

Although AOL Time Warner had revealed this practice in its third-quarter 10-Q securities filing, the extent of its use was not fully detailed until the fourth-quarter report.

In the third quarter, AOL Time Warner said advertising revenue at the Time Warner Cable unit dropped from $83 million to $43 million. The company said it expected fourth-quarter ad revenue to be below that of the same period in 2001, and that overall amounts would be lower in 2003 than in 2002.

Those advertising fees have relatively no associated costs, so they fall almost completely to the bottom line. That boosted cash flow in 2002, and sets up a big hit in subsequent years.

Most cable operators subtract launch fees from programming expenses and amortize the fees over the life of the contract, about five to 10 years.

UBS Warburg cable debt and equity analyst Aryeh Bourkoff estimated advertising revenue for the cable unit at about $230 million in 2002, falling to about $50 million in 2003.

Sanford Bernstein & Co. media analyst Tim Wolzien said that while AOL acknowledged that the advertising and launch fees existed, the speed at which they deteriorated was unexpected.

"The thing that is the surprise was how precipitously it is going away," Wolzien said, adding this development could cause investors to wonder what else they don't know about the company.

"The fact was that they [AOL Time Warner] said it was declining. They didn't say it was going to evaporate," Wolzien said.

Overall, cable operations had strong results in the fourth quarter, with revenue rising 12 percent and cash flow rising 13 percent. Basic subscribers increased by 0.5 percent in the quarter and by 1.5 percent for the year. Digital subscribers rose 8.4 percent in the quarter, and high-speed-data customers were up 13 percent.

All this comes as AOL Time Warner prepares to attempt an initial public offering of Time Warner Cable later this year.

While that offering was expected to raise as much as $4 billion, the IPO could instead reap about $3 billion as a result of the most recent questions concerning the cable operations.

"It may take awhile for the dust to settle," Wolzien said.