Lawyers Licking Chops Over AOL Sub Flub - TheStreet

Lawyers Licking Chops Over AOL Sub Flub

A report that subscription figures were overstated could add to worries on the class-action front.
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Allegations that

AOL Time Warner

(AOL)

may have inflated subscriber counts at its America Online unit could have courtroom repercussions.

On Friday, investors mostly shrugged off a story in

The Wall Street Journal

suggesting that from 2000 to 2003, AOL unnaturally boosted subscriber counts. Such a tale, if true, isn't much of a shock for AOL-watchers, given the company's already well-documented pushing of envelopes in advertising revenue recognition.

Nor does the story introduce new worries about the quality of AOL's subscriber count. Even the company's supporters on Wall Street expect it to lose millions of subscribers over the next half-decade as cut-rate dial-up services and migration to high-speed Internet connections eat away at AOL's subscriber base, which amounted to 25.3 million members at the end of June.

But what the story does appear to do is add one more trump card to the hand of all the plaintiffs lined up to collect damages from AOL Time Warner in shareholder suits. Since investors have been following AOL's subscriber counts closely since the online service first went public, litigious former shareholders could presumably argue that any manipulation of those numbers constitutes fraud. And with AOL shares having plunged since the company's formation through a closely watched 2001 merger, there are plenty of potential complainants out there.

An AOL Time Warner spokesman declined to comment Friday.

AOL Time Warner shareholders couldn't have been pleased with the story, but they didn't appear particularly unnerved, either. The company's shares traded at $15.02 at midday Friday, down 29 cents. Shares have ranged from $8.70 to $17.89 over the past year.

Forget About It

One prominent AOL booster, Merrill Lynch analyst Jessica Reif Cohen, termed the story a "nonevent," saying that the 830,000 bulk-rate subscriptions at issue had been eliminated from subscriber counts by the end of 2002. AOL Time Warner made a passing reference to the bulk-rate program in its annual report for 2001. (Cohen, whose firm has done recent banking and underwriting for AOL Time Warner, upgraded the stock to buy last week, with a 12-month price target of $24.)

AOL Time Warner has already attracted the attention of regulators and disgruntled shareholders over its revenue accounting. Last fall the company said it was subtracting $190 million from previously recorded revenue over eight quarters, and this year the

SEC

has been questioning the recognition of

$400 million of sales to Bertelsmann recognized in 2001 and 2002.

The company already has acknowledged that there are some judgment calls in its subscriber counts. Earlier this month, when Ohio's attorney general filed suit against AOL Time Warner on behalf of state pension funds, the lawsuit cited AOL Time Warner's conference call acknowledgment of including nonpaying free trial subscribers in its subscriber counts.

As for the quality-of-subscriber issue, the bulk subscriptions are no longer a factor in the company's subscriber counts, says Cohen. She, like others, already were predicting that AOL will lose in the neighborhood of 10 million subscribers to discounting and broadband over the next half-decade.

Fodder

But though people have quantified AOL's subscriber-count vulnerability, what's harder to quantify are the legal consequences facing the company. That's where Friday's news may come into play.

The new-subscriber-count story could be fodder for shareholder litigation, most of which is currently focusing on revenue recognition issues. Shareholders could argue that subscriber counts were one of the factors they used to value AOL Time Warner, and any manipulation of such counts constituted fraud.

Whether such fraud is provable isn't clear. Subscriber counts in many industries, including cable TV and magazines, require judgment calls, especially with bulk-subscription deals. AOL Time Warner could argue that its policies in this gray area were reasonable.

But Friday's story could represent new opportunities for litigants to refile complaints. The Ohio lawsuit accuses AOL of inflating subscriber growth through tactics such as counting free-trial participants as paying subscribers, even after their free trials had expired. But the lawsuit doesn't appear to mention bulk deals as a means of such inflation.

A class-action suit led by the Minnesota State Board of Investment doesn't appear to mention subscriber counts at all.