AOL Time Warner ( AOL) shareholders have to wonder how many more cockroaches will come crawling out of America Online.The multimedia conglomerate disclosed late Friday night that the Securities and Exchange Commission is questioning nearly $400 million in revenue recognized by the America Online service over 2001 and 2002. At issue is the accounting treatment of certain 2001 deals with German media giant Bertelsmann. The disputed amount adds to the $190 million that AOL Time Warner, following a review of the online unit's advertising sales, said it was cutting from revenue AOL had recognized from 2000 to 2002. When AOL Time Warner announced that $190 million reduction last October -- two months after saying it was re-examining $49 million worth of transactions -- AOL Time Warner said it didn't anticipate any further restatements. But now, investors must brace for the prospect of yet another restatement, one that would clip 9.5% from the $4.2 billion in advertising and commerce revenue AOL reported over 2001 and 2002. With the latest disclosure, investor faith that AOL's accounting troubles are behind it -- that the company is free to focus simply on old-fashioned underperformance -- seems misplaced. The cockroach theory of accounting problems -- that a single visible problem implies more in hidden corners -- is corroborated once again. So shareholders can wonder whether any additional bad news will come out of the SEC's and the Justice Department's ongoing investigations of AOL's accounting and disclosure practices. And they can also try to figure out how much farther AOL Time Warner's sagging stock can sink. Shares in AOL Time Warner fell 19 cents Friday to close at $11.35. The stock has fallen from a 52-week high of $24.99, but it's still above last year's lows of $8.70.
At issue in the Bertelsmann case is certain advertising deals struck in 2001 while AOL Time Warner was negotiating with Bertelsmann over the dissolution of their partnership in AOL Europe. Under an earlier version of the dissolution pact, Bertelsmann had the right to put its AOL Europe shares -- at a total price of $6.75 billion -- to AOL Time Warner in two stages. AOL Time Warner had the right to choose whether to pay for those shares in cash or in AOL Time Warner stock. In separate agreements reached in March and December of 2001, the companies changed the earlier terms to specify a cash payment, rather than stock. Meanwhile, "contemporaneously" with the agreements to pay in cash, says AOL Time Warner in its filing, the companies reached two separate agreements under which Bertelsmann agreed to purchase additional advertising from AOL Time Warner, valued at $125 million and $275 million. The company and its auditors say the $396.4 million worth of advertising that ran in 2001 and 2002, virtually all of it at the AOL unit, should be recognized as revenue. The SEC staff says it believes "at least some portion of the revenue" should instead have been treated as a reduction in the AOL Europe purchase price paid to Bertelsmann.
Those transactions likely include, for example, deals with online real estate services firm Homestore ( HOMS), alleged to be sham transactions designed to inflate the advertising revenue of both companies. AOL Time Warner "may not currently have access to all relevant information that may come to light" in the SEC and DOJ investigations, the company said Friday. It is possible, says AOL Time Warner, that further restatement of the company's financials may be necessary.