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Morgan Grows Meeker About AOL

The closely watched Net analyst cuts her cash-flow forecasts while maintaining a strong buy rating.

Though Morgan Stanley still rates

AOL Time Warner

(AOL)

a strong buy, the numbers underlying that ranking got a little weaker Wednesday.

Citing diminished expectations for the America Online service's subscriber growth, and for online advertising and commerce revenues, Morgan Stanley analysts Mary Meeker and Rich Bilotti are cutting by 10% their 2002 and 2003 forecasts for AOL Time Warner's earnings before interest, taxes, depreciation and amortization, or EBITDA, a common media industry bottom-line performance measure.

AOL Time Warner shares closed at $31.60 Wednesday afternoon, down 50 cents. Plot AOL Time Warner shares since the deal was announced in January 2000, and you get a 56% loss, compared with a 20% loss for the

S&P 500

.

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Despite their reductions, Meeker and Bilotti haven't soured on the stock: They say a price target of $39 is supported by a cash-flow analysis that peers 10 years into the future. And though AOL Time Warner trades at a premium compared with other media conglomerates using a standard industry valuation yardstick, a related relative measurement supports a price target of $41. (Morgan Stanley has done recent investment banking for AOL Time Warner.)

Excluding consolidation of AOL Europe, Morgan cut revenue estimates 1% for 2002 and 5% for 2003. The new numbers reflect lower growth among AOL subscribers -- 21% on average for each of the next two years, down from a 28.5% target -- as well as worse-than-expected performance in AOL advertising and commerce revenue. Instead of ad revenue growing 1% in 2002 and 25% in 2003, the analysts are expecting a 2% decline and 20% growth, respectively.

Of concern on the AOL subscriber-growth front, says Morgan, is the inevitable maturation of the dial-up Internet access market, as well as AOL's "weak" 4% share of the high-speed Internet access business.

Morgan Stanley is by no means the only organization out there that has lowered the bar for AOL Time Warner. The media company itself

scaled back expectations after the Sept. 11 terrorist attacks. But rather than focusing simply on the weak advertising market throughout the economy, Morgan Stanley is one of several brokerage firms that have more recently focused on an apparent slowdown in domestic subscriber growth.

Meanwhile, Meeker -- queen of the declining and falling empire of Internet stocks -- and Bilotti say AOL Time Warner's stock has plenty of room to grow, according to their relative valuation calculation. Already, they calculate, AOL Time Warner's enterprise value -- roughly, its

market capitalization and debt minus cash and consolidated assets -- is valued at 16.7 times estimated 2002 EBITDA. That's richer than the corresponding multiple of 14 times that Morgan Stanley calculates for a basket of major media companies.

But shifting attention from EV/EBITDA to EV/EBITDA as a multiple of a company's projected five-year average EBITDA growth rate, the analysts say an 18 times multiple is defensible for AOL Time Warner, translating into a $41 price target for 2002's end.

Given AOL Time Warner's volatility and its 52-week high of $58, a $41 target is in the realm of possibility. But its mathematical underpinnings don't appear to be a rock-steady foundation for establishing a kingdom.