Cable able as TW changes face of AOL

America Online will now be a freebie for consumers, but it’s the cable business that keeps on giving at Time Warner.

On an eventful day at TW, conglom on Wednesday disclosed its much-anticipated plans to unlock the gate on AOL email and software but showed that the cable unit remains its engine.

Operating income at the division was up a sparkling 16% to $1.03 billion, with both figures by far the highest at any of the conglom’s units.

But the studio business showed slightly less luster: Warners’ operating income climbed 10%, but revenue dropped 10% to $2.36 billion. Quarter brought “Poseidon,” a pic that gave new meaning to the phrase “disaster movie.” And despite a solid showing for “Superman Returns,” this quarter’s results could prove more of a headache thanks to “The Ant Bully” and “Lady in the Water.”

Overall, TW tucked away a tidy $1 billion in net income during the second quarter, after losing nearly $409 million last year, though that loss came chiefly as the result of a $3 billion legal settlement. Company was able to inch up revenue by 1% to $10.7 billion.

The AOL revamp is a complicated process that involves expanding new initiatives and scaling down old ones, with all the changes based on one idea: audience over access.

By giving away many features to high-speed customers, company hopes to trade the revenue it now receives for services for a significantly larger audience, which will in turn allow it to sell a lot more advertising at much higher rates.

As part of the audience push, company also said it has been reserving email addresses for customers who have defected over the last two years and will now give those addresses back to them. AOL exec Jon Miller also noted a “series of enhancements” that would bring back customers.

Move completes a cultural transformation as well as an economic one. It takes a ’90s powerhouse that made its name on getting consumers connected to the Web and turns it into a company that aims to mix elements of Yahoo!, MSN and Google — and even iTunes and YouTube.

AOL is pushing its entertainment offerings with two new series produced by Mark Burnett and selling episodes of series that air on MTV and TNT.

And it has already moved many of its content offerings from behind its proprietary gate to its AOL.com portal.

Despite calculations that had lead some to think the company will take a hit of $1 billion on the revamp, TW argued the shift would not result in any losses.

Company will no longer be spending money marketing to new dial-up customers it had trouble holding onto anyway, and the savings will balance out about $150 million-$200 million of what it calls “restructuring” costs — mainly the loss of subscription revenue.

The revamp won’t cause an earnings hit in 2006, topper Richard Parsons said, and execs expect earnings will go up as ad business catches on in 2007 and beyond. “Even taking into account the restructuring charges, we don’t see any material step-down in AOL’s earnings for the year,” Parsons said. “If there’s a bias, it will be a slight bias on the upside.”

Company said it expects to save $1 billion in costs with the change.

TW honchos stressed that this dramatic step was a “reshaping” of, not an “exit” from, the access business, but the message was clear: Overhaul the business model, the sooner the better.

In some ways the fate of Parsons rests on this reinvention. Exec has resisted calls to sell AOL outright, and its results will go a long way toward cementing his reputation as brilliantly stubborn — or just plain stubborn.

On Wednesday, the topper received good news: Investors reacted enthusiastically to the overall news, sending the stock up 3%.

But the coupling of the revamp to a robust quarter made it difficult to discern true feelings about the AOL strategy. Real test, analysts said, will come over the next few quarters.

Analysts were also torn on the repositioning. Some noted that the shift fits perfectly with the current fashion on the Web, where subscribers expect to pay less for more and Madison Avenue is more inclined than ever to spend money.

But others said that it’s a mistake to view the strategy as anything close to an end in itself. In a note issued before the briefing, Pali Research’s Rich Greenfield wondered, “How does AOL drive page views after the shift to free?” It’s a shift “that should prevent people from leaving,” he wrote, “but what next?”

Time Warner may not be able to complain too loudly about the decline of AOL’s core access business as it is benefiting from that exodus as much as anyone else. Company had an impressive net gain of 230,000 high-speed Internet subscribers in the quarters — some of them likely AOL refugees.

Solid high-speed numbers helped drive Time Warner Cable, which jumped sub revenue by 16% and total revenue by 15% to $2.72 billion.

Unit is also riding high from the closing of the Adelphia sale this week. But TW declined to say whether it would offer additional shares beyond the IPO of 16% of the company connected to the Adelphia sale.

Film and television studios were a steady, if not overwhelmingly successful, performer, with the company’s great revenue drop coming from “content,” where revenue slid 11% to 2.9 billion.

Networks unit did modestly well as company readies for launch of the CW in the fall; operating income at the unit, which includes CNN, TNT and HBO, climbed 9% to $696 million.

At AOL, results bolstered the case for the shift from access to advertising. Ad revenue grew by 40% while sub revs dropped 11%, with overall revenue off 2% and operating income down 4%.

Still, for all the ad growth, AOL’s ad revenue still stands at only $450 million — less than a third of the company’s subscription revenue.

Publishing continued to be a laggard. Quarter that saw several big changes at the unit, including a new regime at Time magazine, also brought a 2% drop in revenue to $1.32 billion and an operating profit slide of 11% to $272 million. Like AOL, a business once flush with cash has been bloodied by new-media changes.

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