A few weeks ago I sent out my September e- newsletter, "Why Comcast Should Acquire AOL".
I believe I was the first person to publicly suggest this idea, and when I wrote it, I acknowledged that some of you might think I had lost my mind given AOL's sorry track record in M&A. Sure enough, that's how some of you responded!
However, yesterday afternoon Reuters reported that Comcast is indeed considering a transaction involving AOL, and that a deal may also include Google.
I think this news proves at least 2 things: first, that I haven't lost my mind (whew), and second, that Comcast must agree with at least part of my analysis. I won't be so presumptuous as to suggest that I sparked this idea for Comcast's executives, but I wouldn't mind assuming that my words may have helped crystallize their thinking. (Note — I had no inside knowledge of a possible deal)
Regardless, now that Comcast's interest is in open view, kudos to them for stepping up to the plate. Things are moving extremely fast in the online and broadband worlds. In fact, Apple's long-awaited launch of a video-enabled iPod this week was yet another reminder of the disruptive forces blowing through the video distribution value chain.
Comcast has been notably passive in positioning itself (beyond its role as the largest broadband ISP) to exploit changing consumer behaviors that are creating enormous new opportunities in broadband. The right deal with AOL would be a significant milestone in Comcast's evolution beyond its MSO roots. Having Google participate, under the correct conditions, would only be additive. Either way, keeping AOL out of MSN's (or Yahoo's) hands is critical to Comcast's future competitiveness.
For those of you new to this newsletter, or for those who either missed it last month or want to re-read it, read on to see why an AOL deal makes so much sense for Comcast.
Why Comcast Should Acquire AOL
September, 2005
Conspicuously missing from Comcast's recent flurry of video content deals (e.g. MGM, NHL, PBS Sprout, etc.) is any significant initiative in the online media and communications space.
As a result, I think Comcast is missing out on a strategic new growth opportunity, as well as a chance to shift the competitive landscape in its favor.
Comcast has been a quiet bystander while traditional and online media companies have spent billions this year deepening their commitments to these fast-growing areas. These market participants have realized that in the internet age, corporate strategies and product innovation must be guided by rapidly changing consumer behavior and technology innovation.
The massive opportunities being created in online media (surging advertising growth, increased consumer usage, broadband penetration, technological innovation, etc.), plus the dramatic changes sweeping through traditional media (audience fragmentation, on-demand expectations, advertising disruption, etc.) are continuing to blur the boundaries between traditional and online media.
Cable Broadband and Competition
Today cable is facing fierce price-based competition from telcos' DSL services. As the market shifts to moving dial-up holdouts up to broadband, price is becoming an increasingly important weapon. (Note that an August study by SG Cowen found that cable broadband prices are now almost 76% higher than telco broadband prices). Meanwhile, as telcos roll out fiber, they are going to squeeze cable for subscribers willing to pay higher prices for higher speeds. (I just got a Verizon FiOS offer for 15 mbps for $45/mo).
Further complicating the picture is that today third parties such as AOL, Yahoo, CNET, NYTimes.com and others are using broadband distribution to deliver video directly to their intended audiences, without a business deal with the MSO. As this "cable bypass" activity accelerates, it is extremely threatening to cable's traditional operating model.
With all of these forces at work, it is becoming more urgent for Comcast to do two things: change the dynamics of competition in its favor and open up new growth opportunities for itself.
Changing Comcast's Competitive Dynamics
Changing how Comcast competes requires it to broaden its vision of what business it is in. With all of its cable TV-centric deal-making, Comcast must be wary not to fall into the trap of thinking it is still mainly in the cable TV business. Those days are past. And like the railroads of old which didn't recognize that they were no longer in the railroad business, but rather in the broader transportation business, Comcast and other MSOs need to recognize that they now compete in a world well beyond cable TV and which is increasingly broadband-centric.
I believe this viewpoint would result in Comcast embracing online media and communications as a key driver of its competitive differentiation. While advanced TV-based services like VOD, HD and DVR are all important in providing more value on the cable TV side (and in competing with DBS), it is more apparent with each passing day that TV is no longer the center of the universe for many consumers, particularly younger ones.
Increasingly, the broadband internet is the media that consumers use to organize and lead their lives. This includes how they find information about TV and entertainment services. And more recently, it also includes actually consuming video over broadband connections. As just one data point, CNN.com recently reported that on August 29th it served a record 9 million video streams about Hurricane Katrina.
This is not a passing fad. There is huge momentum behind broadband video, and more and more companies are jumping in. While a handful of MSOs, including Comcast, are doing yeoman's work educating consumers about TV-based VOD, an entire ecosystem of other companies, including AOL, are creating a strong tailwind for broadband-delivered video.
Though DirectTV and Echostar are Comcast's toughest video rivals today, five years from now they'll be replaced by companies like Yahoo, Google, MSN, AOL and a myriad of others as they bypass MSOs to deliver millions of hours of personalized, high-quality video directly to their audiences.
Rather than resisting or ignoring these trends, Comcast and other MSOs should get in front of them. With the largest number of broadband subscribers, Comcast is well-positioned to exploit broadband video, opening up a huge range of video choice for its consumers. With its subscriber reach and promotional clout, Comcast could help create exciting new broadband-based programmers, as well as offer new value to its existing programming partners.
Exploiting broadband video is also a key defensive tactic against the upcoming launches of telco-based IPTV. Broadband video gets Comcast into IP-based video distribution in the home by leveraging existing infrastructure (cable modems, PCs, wireless networks, etc.), avoiding for now costly set-top box replacements.
By changing the competitive dynamic to favor online media and communications, Comcast would be taking a leadership role in giving consumers what they want — great customer experiences including a rich selection of quality video programming and internet services — across TV, PC and other devices. Providing these kinds of distinctive consumer services would be a meaningful new competitive differentiator for Comcast.
Opening up New Growth Opportunities
In addition to improving its competitive position, Comcast would be accessing a world of important new online revenue opportunities. These fall into three categories — advertising, subscription and commerce.
Online advertising is booming today. It is projected to be the fastest growing advertising category over the next five years, amounting to anywhere between $20 billion and $30 billion per year by 2010 according to various estimates. Given the number of broadband eyeballs Comcast reaches and the fact that it has a strong ad business of its own to leverage off of, Comcast could become a primary beneficiary of these online advertising trends.
Beyond online advertising, online subscriptions are also expected to grow as their value propositions improve. These span both content and communications services. On the content side, Comcast is well-positioned to work with its programming partners to create highly complementary subscription offerings to existing cable TV services. Meanwhile, communication services utilizing broadband are proliferating. Ebay's recent purchase of Skype underlines the popularity of IP-based messaging. Consumer acceptance of these cutting-edge communication tools is very strong. These kinds of broadband communications initiatives neatly complement Comcast's budding VOIP service.
Finally, e-commerce continues to grow rapidly and there is more and more value for companies in being the traffic cop, directing consumers to particular online outlets. Through comparison shopping engines, private-labeled stores, affiliate marketing and other tactics, monetizing traffic though e-commerce is becoming more prevalent. In fact, last Christmas season Comcast pursued initiatives in the commerce area, which it will no doubt continue.
AOL would be a Strategic and Transformational Acquisition
Given the importance of increasing its competitiveness and driving new revenue growth, the question becomes: how can Comcast best achieve these goals?
I acknowledge how tempting it is to dismiss the idea of Comcast acquiring AOL as pure folly given the colossal failure of the AOL-Time Warner merger.
Notwithstanding the company's admirable portal, Comcast.net, Comcast has relatively limited skill sets in online media and communications. With these online markets are moving so fast, I think it would be extremely hard for Comcast to pursue these goals on its own. So that means that Comcast would need to make a significant acquisition to accelerate its efforts. Though far from perfect, for many reasons AOL is likely the only sizable candidate to consider for acquisition.
So I believe that at an appropriate price, and if managed correctly (admittedly both big questions), AOL would be a strategic and transformational acquisition for Comcast, with high long-term competitive and financial benefits.
What AOL Offers
AOL still possesses one of the most recognized names in the online business, along with a diverse portfolio of valuable properties. AOL is in the midst of executing its own transition from a dial-up subscription business to an advertising-supported online media and communications business.
AOL is one of the leading internet destinations, with 90 million unique visitors and 26 billion page views in August. This is the underpinning of AOL's new strategy of moving content out from behind its "walled garden", and also developing innovative new services. AOL has publicly stated that exploiting broadband's pervasiveness is a key driver in its plans, and many of its new content efforts are focused in the music, TV and entertainment areas. AOL is playing a key role in deploying new broadband video services and using its video search, based on SingingFish (an AOL acquisition), to help users navigate the burgeoning volume of AOL content.
AOL is exploiting its massive audience base to tap into the surging market for online advertising. I'm cautiously optimistic that AOL can successfully pull this transition off, and the early results are encouraging. In the latest six month period ending June 30th, AOL increased its ad revenues from $435 million to $631 million, improving their contribution to total revenues from approximately 10% to approximately 15%. As continued proof of its success becomes evident, AOL's valuation will certainly increase.
Meanwhile AOL has stepped up the pace of developing and integrating new technologies into its products and services, with recent announcements/acquisitions in VOIP, instant messaging, mobile, RSS, podcasting, remote storage and others.
These could all be highly valuable ingredients for Comcast to change its competitive standing and access new revenue opportunities. Again, depending on the acquisition price, I believe a very solid case could be made to justify the deal on both strategic and financial grounds. In fact, I think its logic would be more tightly focused and compelling than the logic Comcast offered to support the failed Disney acquisition.
The Challenges
First, persuading Time Warner to part with AOL, and then agreeing on price, would not be easy. In fact, despite rumors of an MSN deal (or because of them!), TW CEO Richard Parsons has lately been touting the importance of AOL to TW. With the MSN discussions disclosed, it seems highly plausible that AOL may be in play. (And by the way if AOL does align with MSN, this would be a real negative for Comcast.) While not the richest bidder, Comcast may actually have some advantage if it were competing with Microsoft, and possibly Google and others. Since Time Warner Cable could benefit from some of the same initiatives AOL would pursue under Comcast, a deal could involve a larger strategic partnership between TW and Comcast in the online area. Plus these companies have a long industry history together, which may be helpful on the margin.
Second, there's the melting iceberg of AOL's dial-up business. How this business should be valued, and what should be done with it? No easy answers here, except that competition among broadband ISPs to acquire these dial-up subs will be stiff, so to the extent that Comcast can monetize their transition to broadband (e.g. reduced acquisition costs bringing them over to Comcast's broadband service or bounties from out-of-footprint broadband ISPs), there is likely value to be found. In the meantime, these dial-up subscribers could exist as low-end Comcast internet subscribers. And remember, they're still a big part of helping AOL generate EBITDA of approximately $2 billion this year.
Finally, the big question — can Comcast succeed with an AOL deal where Time Warner could not? I'm a self-confessed skeptic about corporate M&A and this deal would bring far different challenges than cable-centric deals like AT&T Broadband and Adelphia. Nonetheless, I am fairly confident that Comcast could pull off an AOL marriage.
Keep an eye on upcoming developments to see if Comcast agrees with my logic and makes a move on AOL.
