For America Online chairman Steve Case, 1997 has been the best of times and the worst of times. His company is at the vanguard of a revolution in cyberspace, with the percentage of US households plugged into online services almost doubling in the last two years (from 10 percent to 19 percent).
Better yet, Americans are logging on more than ever, checking e-mail, yakking it up in myriad chatrooms, and browsing for consumer goods at a rate of almost 13 hours per week (up from six-and-a-half hours in 1996, according to Odyssey, a San Francisco-based high technology market research firm). The best news? AOL’s stock price spiraled upward to $87 in late October, about four times its 52-week low of $22.
But Case and AOL can’t seem to shake the bad publicity fueled by a combination of questionable marketing practices and a perception by users, who regularly wait an hour or two for e-mail to go through (not too slow in the real world, but an eternity in cyberspace), that the online service’s telecommunications technology just isn’t getting it done.
In addition, AOL still suffers from a nagging hangover after its decision to sell customer names and addresses to telemarketers backfired and after its ‘unlimited’ $19.95 per month user fee campaign made its system groan under the weight of 9 mn users trying to dial in.
But hey, nobody ever said commercializing cyberspace would be easy. And nobody’s done it any better than AOL, which has capped off its year of living dangerously with a crafty three-company deal that resulted in the company adding Compuserve’s 2.6 mn users to its subscriber rolls.
Anatomy of the Deal
Here’s a snapshot of the three-way deal: On September 8, Columbus, Ohio-based H&R Block, Compuserve’s parent, announced that it would sell the online service to WorldCom of Jackson, Mississippi, later to become MCI’s surprise suitor, in a stock-to-stock transaction valued at $1.2 bn. Under the terms of the agreement, Compuserve shareholders received a fixed exchange ratio of 0.40625 shares of WorldCom stock (which was trading at around $34 in late October) for each share of Compuserve. Based on the WorldCom stock price of September 5 – the Friday preceding the announcement of the deal – the transaction was valued at about $12.80 per Compuserve share.
WorldCom tossed in some protection for Compuserve shareholders as well: if WorldCom’s stock price falls below $29.54 per share (on the Tuesday following the Dow’s 554 point decline, WorldCom shares flipped to $28 5/8, but rebounded to $31) the fixed exchange ratio converts to a fixed price of $12 per share. And if WorldCom stock drops below $24, then the pricing structure converts to a fixed exchange ratio of 0.5 and Compuserve gains the right to deep-six the deal. (WorldCom has a similar undercap in its bid to purchase MCI Communications Corp. In that deal, WorldCom has offered to pay $41.50 per share in stock for MCI as long as the stock price remains above $34. On October 25, it fell to $33. At that level, MCI shareholders wouldn’t get more than 1.22 WorldCom shares for each MCI share. And under those conditions, British Telecom’s reformulated bid of $28 bn in cash looks pretty good).
In the end, it’s not a bad deal for H&R Block and Compuserve shareholders. Block gets 3 percent of WorldCom stock and has plenty of options to convert its stock into cash. On the other hand, what becomes of Compuserve and its loyal band of followers? ‘I don’t know,’ says company spokesperson Steve Conway. ‘Everyone, including our business vendors, have been asking us that and we’ve been telling them the same thing – ask AOL and WorldCom.’
That said, there is clearly a sense of relief among Compuserve senior managers that the company got the best deal it could. ‘There’s a right time to sell, and this was the right time, the right price, and the right path for future growth,’ demurs Frank Salizonni, president and chief executive officer at H&R Block. ‘It’s a strategic transaction that provides significant value to both H&R Block and Compuserve shareholders. And, the deal places Compuserve assets in excellent hands for the benefit of its networking and online customers.’
And guess whose hands the latter fall into? None other than AOL’s. Under a subsequent agreement between WorldCom and AOL announced later the same day, WorldCom traded the online customer portion of Compuserve in return for AOL’s ANS Internet network subsidiary, one of the largest such networks in the world.
Under the terms of that deal, WorldCom will also pay $175 mn in cash while retaining Compuserve’s Network Services division. AOL also agreed to sign a five-year deal with WorldCom under which WorldCom’s new ANS division will become AOL’s largest network services provider. In short, AOL gets the glittering new showcase kitchen and bath while WorldCom gets the plumbing. WorldCom execs seem happy with the results.
‘We believe these moves further distance us from the traditional carriers, as we continue to build a different kind of communications company,’ argues WorldCom chief executive Bernard Ebbers. ‘I think the transaction underscores our belief that the communications marketplace has fundamentally changed. In this new world, all customers are demanding increasingly advanced Internet and data networking services. The Compuserve/AOL deal will strengthen and broaden our Internet business.’
The core network infrastructures of both ANS and Compuserve, together with WorldCom’s existing UUNET dial network, give the rejigged company over half a million access ports – the gateways to cyberspace – all across the world.
Some say the price paid by WorldCom was high. But company managers insist it’s worth it. ‘In the Internet game, you need the best talent available, and that’s what we get in this deal,’ says Gary Brandt, vice president of investor relations at the company. ‘Unfortunately, right now talent is at a premium.’
Brandt, who says that investor response to the AOL/Compuserve deal ‘has been very positive’, adds that each of the three companies in the deal brings something unique to the table: Compuserve its large corporate customer base; AOL its dial-up access and network service unit; and WorldCom its tremendous capacity, which only grows stronger as a result of the deal.
‘With the Internet industry growing and becoming more competitive, those assets will be put to use quickly,’ Brandt says. ‘In the worldwide move from voice to data communications, we’re going to have a tremendous advantage over traditional telecommunications companies.’
Sultans of Cyberspace
And what of AOL? The sale of networks to WorldCom is valued at over $425 mn. The company will put some of the cash to use right away in a joint venture with its European arm, Bertelsmann, to beef up Compuserve’s European presence. And by shedding its Internet networking subsidiary, AOL can focus squarely on its core assets, AOL Networks and AOL Studios. The company also plans to assuage the concerns of many AOL users who remain unhappy with log-on delays and the like by installing over 100,000 new modems as part of its deal with WorldCom.
‘I think we’ve made tremendous strides over the years and this transaction is an example of that,’ comments AOL’s Case. ‘Now we can boost our momentum by concentrating on our core interactive services and content businesses. In addition, the Compuserve acquisition will help fuel our global expansion – especially in the critical European marketplace.’
Indeed, the partnership between AOL and Bertelsmann has become the leading pan-European online service provider only two years after roll-out, with 1.5 mn subscribers. AOL has also recently launched online services in Asia, Latin America, Australia and Canada (100,000 customers already). The Compuserve deal adds 300,000 new members in those venues.
While the investing public has given AOL a thumbs-up for its handling of the deal – the company’s stock rose $18 in the six weeks after it was announced – much is being made about AOL’s goal of increasing its proportion of income from advertising and commercial ventures like online shopping from its current level of 15 percent to 50 percent in the next several years.
But will end users, already weary of long log-on times and endless pitches for AOL products, be willing to sit through even more ads before they can check in with Aunt Hildie in Poughkeepsie? Given the immediate gratification temperament of today’s cyberwarrior, they might not.
Still, AOL has with one fell swoop clearly repositioned itself as a mega-media empire on a par with the Time Warners, Microsofts and Viacoms that it expects to compete against in the coming years. And as 1997 draws to a close, AOL is at the top of the heap when it comes to the interactive portion of the new media game. But as Steve Case has said, there’s still a lot of work to be done before interactive services are mass-market media. Sounds like he’s already booked for 1998.
