Is AOL still a Net company?

Shares in America Online fell more than 9 percent today in midday trading as investors digested the ramifications of its proposed acquisition of Time Warner.

AOL announced yesterday that it will acquire the cable firm for stock valued at about $160 billion, marking the largest corporate buyout in history. AOL is buying Time Warner to gain access to its widespread high-speed cable networks, huge customer base, as well as its television, print and Internet media properties.

Yet as a result of the acquisition, some analysts are expressing concerns that AOL will no longer be a "pure-play" Internet company, tossing aside the stellar growth and stock gains many Net firms have enjoyed over the past year.

Investment banking firm Schroder & Co. downgraded AOL stock, and cut its 12-month price target to $85 per share from $105, while removing AOL from its recommended list.

"The merger will dramatically transform AOL and Time Warner, with (the new company) having tremendous cash flow and greater earnings predictability, but much slower growth than AOL pre-merger," Schroder equity analyst Arthur Newman wrote today in a research report.

AOL's high-flying stock, up more than 1,300 percent since this time two years ago, afforded the company the currency to buy not only Time Warner but also Netscape and CompuServe in recent years.

By riding the Internet wave, AOL has minted a number of stock-option millionaires. In late 1998, the firm became the first Net company to be added to the Standard & Poor's 500 index.

But now some analysts are questioning whether investors will continue to consider AOL a true Internet stock.

A shift would be no trivial development: More traditional companies are typically valued on earnings and expected growth in earnings. Investors determine the value of Net stocks based on factors such as revenue growth, gains in traffic or e-commerce potential. The result is that many Net companies have no profits and slim revenues, but still have market valuations in the billions of dollars.

"The big question for shareholders is whether the market will accord the new entity a traditional valuation or an 'Internet valuation'," Merrill Lynch analyst Henry Blodget wrote in a report today. Blodget has a "buy" rating on AOL stock.

Near the close of regular trading, AOL shares were down $7.13, or about 10 percent, to $65.50. Time Warner, whose shares are now linked to fluctuations in AOL's stock price, was down $4.81, or about 5 percent, to $85.25.

Investor reaction to AOL is not unique. Stock in Qwest Communications International took a dive last year shortly after announcing its plan to buy local carrier US West. Analysts have said investors had trouble deciding whether the fiber-optic upstart should continue to be valued like an Internet infrastructure firm, or like the slower-growth local phone company it was acquiring.

The combined AOL-Time Warner also will attract a different type of investor. Many individual investors and day traders, who often value growth prospects more than profits, own AOL and many other Net stocks. However, large traditional media companies often are judged more on earnings per share and other traditional metrics.

AOL has a price-to-earnings (P/E) ratio of about 300. The P/E ratio is determined by dividing the share price by annual per-share earnings. A high ratio means that the shares are trading at a greater premium compared with earnings.

Time Warner has a P/E ratio of about 285, although that number grew as shares swelled following yesterday's announcement. As of last Friday, Time Warner shares carried a P/E of about 215.

Comparing AOL's P/E to other Net companies is difficult for one reason: AOL actually has profits, and therefore a P/E ratio.

Excite@Home, a provider of high-speed access and content, and Inktomi, which provides technology for speeding up deliver of Web pages, did not log any profits in the previous year. Portal firm Lycos also did not report any profits, but it is expected to this year. If Lycos meets current earnings expectations, its shares are trading at a P/E equal to about 775.

Meanwhile, media companies generally do report profits, and much slimmer P/E ratios. Here are a few: Viacom, 125; The Walt Disney Co., 55; Gannett, 25; CBS, 309; and McGraw-Hill, 31.

Merrill's Blodget believes investors will continue to value AOL as an Internet stock "at least for a while yet" but later will have to decide whether AOL Time Warner should be valued as a Net company or a media firm.

Blodget wrote: "Our answer to this is not surprising: probably somewhere in between."