Credit analyst: AOL new deal prudent, but sees little upside

By Ronda Fears

Nashville, Tenn., April 4 - Nobody could argue with the prudence of AOL Time Warner's (Baa1/BBB+) move to extend its maturities by refinancing bank debt and commercial paper with $6 billion in new term debt, observed Carol Levenson, director of research for Gimme Credit. But there is potential credit downgrade risk, as AOL's debtload will not likely decline much near-term, she added, so there is little upside potential in the credit.

"How could management resist capitalizing on the company's status as one of the few BBB names out there not currently tainted by some scary accounting, legal, or liquidity story," Levenson noted in a report Thursday.

While AOL has said the maintenance of strong investment-grade ratings is a sacred corporate goal, the analyst said she feels in a best-case scenario the company would merit a strong BBB credit quality assessment due to a dramatic cut back in its EBITDA growth targets for this year and borrowing $7 billion to buy out its partner in the money-losing AOL Europe.

"We preferred to think of it as a mid BBB with another one notch downside potential for event risk," Levenson said in the report.

"We see no reason to revise our opinion, management's protestations to the contrary. There are simply too many tempting acquisition opportunities out there for a company whose growth and stock price is disappointing its shareholders, whose balance sheet could be considered underleveraged and whose stock is unlikely to be attractive acquisition currency for the time being."

Since the Time Warner merger, the analyst pointed out that AOL's net debt has increased by $3.5 billion, and that was before taking on another $8 billion in borrowings and assumed debt for the AOL Europe purchase.

Moreover, depending on what one wishes to count in the way of additional obligations, AOL has at least another $9 billion in off-balance-sheet obligations, including guarantees, securitizations and operating leases.

Even if AOL meets its free cash flow objectives this year, which is expected to be significantly higher than 2001's proforma adjusted amount of $2 billion, Levenson doesn't expect AOL to use the cash to reduce debt.

The company's pending goodwill impairment charge of $54 billion - 37% of the purchase price of Time Warner - while enormous, will still leave it with an inordinately asset-light balance sheet.

Out of roughly $154 billion in non-current assets remaining after the write-off, there will still be $74 billion in goodwill and intangibles, $27 billion in cable and sports franchises, $14 billion in brands, trademarks, music catalogues and copyrights, $7 billion in investments - a portfolio already written down considerably - and $9 billion in non-current inventories, film costs and other assets.

The analyst noted that the value of the AOL assets is volatile and difficult to quantify.

"Despite its huge subscription base and plethora of major brands, AOL remains a media company, and as such is subject both to economic trends (as they affect advertising spending) and those of taste and fashion," Levenson said in the report.

"As such, we would like to see it carry somewhat less than a $30 billion plus debt load. On the other hand, we don't see management intentionally jeopardizing AOL's investment grade ratings, although the Malone factor intensifies our event risk concerns. We consider the new issue fairly priced, but we see little upside here."

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