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AOL’s funky capitalization of what I believe are operating expenses — specifically, the cost of customer acquisition have raised eyebrows for years. But have they really reformed their ways? I don’t think so. Neither do some analysts. Interestingly, though, since AOL is apparently using a friendly analyst (ie. one who owns 4% of the company) to raise the issue, they have a plan for covering their tracks.

-Ian.

———- http://biz.yahoo.com/ft/020715/1026553453991_2.html

Monday July 15, 11:53 am Eastern Time

FT.com Controversy haunts AOL six years on By Richard Waters and Tim Burt

 AOL Time Warner is no stranger to accounting controversy.

Six years ago, bowing to criticism about the way it capitalised some of the costs of acquiring subscribers for its online service rather than write them off immediately, the company changed its policy and took a write-off of $385m, a move that turned a once-profitable company into a loss-maker.

A new spate of accounting and disclosure questions has now returned to haunt AOL, echoing the wider disquiet about financial reporting by American companies. 

And while most analysts and investors discount the risk of any deep problems to do with the company’s reported figures, the issues at the heart of the accounting debate touch on the same questions raised by AOL’s six-year-old controversy: are some of the costs of the company’s subscription businesses incorrectly capitalised, and what exactly is the state of its core online services business?

John Malone, chairman and controlling shareholder of Liberty Media, which owns a near 4 per cent stake in AOL, is among those who expect the company to come under a continuing barrage of questions about its accounting. Some of that scrutiny may even throw up valid questions about the company’s financial reports.

Speaking last week at the Sun Valley media conference, Mr Malone said he would not be surprised if “there were income recognition issues at AOL”. But he insisted that such issues were not material and would not alter his view of the company’s value.

Mr Malone said AOL’s underlying cashflow was robust, adding that the “only softness” was in its music business.

That is a view echoed by analysts and investors, who point to the underlying strength of the Time Warner media and entertainment businesses. “They may be low-growth media assets, but they’re good assets,” says Rob Gensler, a portfolio manager at T Rowe Price.

However, that has not stopped the continuing round of questions about AOL’s accounting and disclosure policies. Adding to the nervousness has been a succession of financial revelations this year that have surprised Wall Street, including the scale of losses from the company’s European operations, which it has been forced to assume in full after the end of a partnership with Bertelsmann.

The questions about the AOL online service in recent months have revolved around two issues: whether the quality of its subscriber base is deteriorating more than the company’s financial disclosure would suggest; and whether its dependence on advertising from other AOL Time Warner divisions, led by Richard Parsons, is masking a deeper underlying deterioration in its advertising and e-commerce business.

Despite concerns among some analysts in recent weeks, AOL is expected to register another increase in its core subscriber numbers when it reports its latest earnings next week, from the 34.6m reported in March. However, the income it earns from each subscriber has fallen, prompting questions about whether subscriber numbers have been inflated by the inclusion of people on free service trials. 

According to Jessica Reif Cohen, media analyst at Merrill Lynch, the average monthly revenue per customer (a key metric for all subscriber businesses, known as ARPU) has fallen by $3 in the past two years, despite a $1.95 increase in the price of basic service.

Among the factors behind the fall is the fact that AOL’s 10-year-old policy of including a new subscriber once it gets the person’s billing details, even if this is followed only by a free trial period, remains. That policy has not changed in 10 years and AOL’s practice of offering free trials is a effective way of expanding its audience, says Ms Cohen.

Defending its policy on subscriber numbers, Bob Pittman, chief operating officer, said earlier this year that AOL manages its customer base for growth and market share, rather than ARPU.

Mr Pittman has also been a vociferous advocate of AOL Time Warner’s policy of directing more advertising from its Time Warner divisions to its online service – a plan that has helped to stem some of the decline in AOL’s reported advertising amid the broader collapse in internet marketing. Despite that, the AOL service is still expected to report a fall of about 40 per cent in second quarter advertising and e-commerce revenues next week.

Meanwhile, AOL’s cable operations have become a second focus of accounting questions, amidst following the wider concerns that have hit the cable sector recently.

The question, for AOL along with other cable companies, has become: “What’s capitalised, what’s real?” says Mr Gensler.

AOL’s policy of capitalising some of the costs of providing new services, such as high-speed internet access, to existing cable customers is in line with other cable operators and US accounting rules, says Ms Cohen.

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