AOL ads in decline

Cable costs rise while revenues go down

NEW YORK — AOL Time Warner hit paydirt this past weekend with teen horror pic “Freddy vs. Jason,” but the double whammy of slowing ad revenues and rising program costs at its cable systems kept investor enthusiasm in check Monday.

AOL Time Warner warned in its quarterly 10Q financial disclosures to the Securities & Exchange Commission late last week that advertising weaknesses at its AOL online and cable TV system are likely to continue for the balance of 2003. Company also revealed that programming costs at Time Warner Cable are likely to grow by 16% in the latter half of this year due to sports program cost increases and fewer free channels; costs rose 13% in the same period last year. Moreover, filmed entertainment cash flows will likely slow in the back half of the year, due to declines in TV syndication and higher television production costs.

Unfortunately for investors, the disclosures did not shed much new light on the duration or potential financial impact of the ongoing SEC and Dept. of Justice investigations into AOL TW’s accounting practices. However, the company did imply that the feds have widened their probe to take a closer look at how online service AOL has been reporting its subscribers.

Company indicated further restatement of its financial accounts may be necessary. “It is also possible that, so long as there are unresolved issues associated with the company’s financial statements, the effectiveness of any registration statement (for IPOs or other public fund-raising efforts) of the company or its affiliates may be delayed.”

As for its balance sheet renovations, company said it was on track to reduce its net debt to $20 billion by the end of 2004, using a mix of free cash flows as well as selling “non-core assets.”

Several sports teams and possibly programming assets could be divested to reduce its $26 billion load.

The most imminent upcoming deals, however, may involve its two 50/50-owned joint venture cable operations with Comcast. The two systems AOL manages, Kansas City Cable Partners (serving some 300,000 basic subscribers) and Texas Cable Partners (roughly 1.2 million basic subs) are subject to buy-sell provisions that kick in this fall.

Time Warner Cable has confirmed it does not intend to buy out either of these operations, leaving the way clear for a Comcast consolidation play, possibly in exchange for part of its 21% stake in TW cable.

Over a barrel?

Comcast chief Brian Roberts has indicated he is willing to consolidate the systems, possibly in exchange for stock or other assets. But Comcast may have AOL TW over a barrel. The Philadelphia-based operator owns $1.5 billion in AOL stock in addition to the equity stake in cable for which it can demand an IPO. But Time Warner has conceded that undertaking a stock listing for its cable unit while SEC investigations are outstanding could be difficult. Comcast said earlier this month that it would consider “strategic alternatives” with unnamed AOL Time Warner assets if cash is not possible.

While Time Warner Cable revs were up in the last quarter thanks to new high-speed data subs and higher basic-cable fees, advertising revenue is expected to continue to decline in 2003. Company said the falloff is primarily due to fewer cable nets promoting their channels, as well as fewer new channel launches. Ad revenue fell to $6 million for the six months ended June 30 from $82 million a year earlier. Some of the decline is attributable to a falloff in “intercompany sale of advertising to other business segments of AOL Time Warner,” to $4 million in the first half from $58 million in the year-earlier period.

“The company expects advertising to continue to decline throughout 2003 as compared to 2002, due to a decrease in intercompany advertising revenue and an approximate 90% decline in advertising purchased by programming vendors, primarily due to fewer new channel launches,” AOL noted in the filing.

Sports get pricey

At the same time, AOL TW noted that cable programming costs will rise by 16% for the rest of 2003 at its cable systems. Company blamed sports programming cost inflation (including launch of new sports services and rate increases for existing channels like ESPN) and the addition of many new non-sports services to its lineups and general rate inflation for certain channels.

Company suggested programming costs in the second half of 2003 will continue to rise as introductory and promotional periods for some channels expire and as industrywide programming cost increases continue with larger programmers.