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July 05, 2006

Major Layoffs Coming at AOL? If So, It Is Bad News For Time Warner

I read a post on Henry Blodgett's blog about two weeks ago alluding to the major layoffs at America Online (AOL). I do not know the writer, but I have found the discussion at Henry's blog to be quite good. SInce then, more outlets are reporting rumors of large layoffs and weak advertising growth. There is no confirmation yet from management of AOL's owner, TIme Warner (TWX), but I think major layoffs at AOL are a big negative for TWX shares.

Major layoffs at this point are a sign of weakness given that some key new strategies for saving AOL have been in place for almost a year. Layoffs indicate that the broadband rollout is either not getting enough subscribers or not producing enough profits or both, and/or that dial-up subscriber losses remain elevated. Any of those outcomes is menas that advertising growth at AOL.com, the key to AOL's turnaround strategy, is falling short of expectations.

I think there is a risk that implied valuations in TWX shares of up to $20 billion for AOL may implode. This has serious downside implications for TWX, since any meaningful downgrade of AOL's value across TWX's 4 billion-share base is significant relative to a $17 stock....

Is it possible that AOL is worthless beyond the liquidation stream associated with the remaining dial-up subscribers? It could be. Keep in mind that AOL.com advertising revenue is largely driven by AOL dial-up and broadband subs. If those disappear, the value destruction implications are real.

Remember that the sum of the parts at AOL, using comparable multiples for its key division on real companies like Comcast (CMCSA) and Viacom (VIA), only creates value of about $20 even after the share base shrinks from the big buyback. Unless you think the market is going to revalue the multiples upward on cable, cable network, film and TV production, and publishing assets, there isn't that much value at TWX.

Posted by Steve Birenberg at July 5, 2006 09:00 AM in TWX