Moment of truth in AOL charges

TW to face claims of misleading ad revenue reporting

This article was updated at 7:00 p.m.

NEW YORK — Time Warner’s regulatory battles may be coming to a head, with reports Tuesday that the SEC will charge the conglom with accounting fraud relating to $400 million in improperly booked funds involving AOL Europe’s partnership with Bertelsmann.

TW has previously acknowledged that it’s in dispute with the feds over the handling of the transaction, but the expectation of a formal charge could crimp any near-term strategic dealmaking by the conglom.

The Securities and Exchange Commission investigators insist the online group overstated revenues by recording a reduction in the price of Bertelsmann’s interest in AOL Europe as AOL ad revenue.

The feds could formally notify Time Warner of the charges by early summer.

The subject of whether AOL was entitled to record $400 million in ad revenue is part of the wider accounting dispute between TW and the SEC that has shown no sign of conclusion and continues to cast a pall over the company’s inert share price.

Such potentially misleading accounting treatments would have reduced AOL revenues at the time, giving investors a truer picture of the firm’s fiscal health. The feds have been trying to collect evidence that management intentionally misled shareholders about AOL’s fiscal health in 2001 and 2002 by overstating ad sales and inflating subscriber numbers.

Government insists that some or all of the $400 million sum should have been recorded as a discount to the purchase price, not as ad revenue.

Included in price

America Online’s $6.75 billion 2002 purchase of Bertelsmann’s stake in AOL’s European operations included the $400 million in AOL ads.

Time Warner said it discounted the purchase price by that amount in order to account for the German company’s ads on AOL in 2001 and 2002 while booking the $400 million as ad revenue for those years.

Trouble is, Bertelsmann never recorded any ad expense to that effect. The SEC maintains that AOL action was inappropriate and was done in order to meet TW management’s financial targets.

TW would only say that the company intends “to continue its efforts to cooperate with both the SEC and the DOJ investigations to resolve these matters.”

Company already restated $190 million in dubiously recorded ad revenue unrelated to the Bertelsmann deal in late 2002.

The SEC is said to be probing other similar transactions that could require the company to restate past financials.

According to the Washington Post, the feds could seek penalties against TW for failing to cooperate sufficiently with the investigation.

May hurt bid for Adelphia

Analyst Todd Mitchell of Blaylock & Partners said if the SEC charges come to fruition, it could put a damper on any TW strategic initiatives, including a possible bid for cable operator Adelphia, a possible IPO of its own cable unit or any “strategic” deal with AOL itself.

Mitchell also noted that the potential cost of several pending shareholder lawsuits will likely rise if the SEC charges stick.

“The silver lining in today’s news is that we may be nearing the end of AOL’s SEC investigation, which began originally in August 2002,” said JPMorgan analyst Spencer Wang in a note published Tuesday.

Once Time Warner receives the official SEC notice, it has several weeks to respond and can attempt to negotiate a settlement. Otherwise, the SEC could file a federal civil court action.

TW, which is due to report first-quarter 2004 financial results April 28, has been weighed down by regulatory and strategic questions swirling around online unit AOL.

Investors cautious

The likelihood that the company will make a cable system acquisition is also keeping investors cautious in spite of what is expected to be another strong quarter from the cable network unit.

The company may be looking to make an offer for Adelphia, particularly if the latter’s bankruptcy judge rules April 26 whether various reorganizations plans can be reviewed by the court, thereby opening the possibility of an earlier-than-expected bidding war for the assets.

Adelphia assets could go for as high as $20 billion, with Cox and Comcast also considered contenders.

TW shares fell 2.7% Tuesday to close at $16.90.

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