More Gut Punches For AOL

AOL Time Warner Inc., which has already become a punching bag on Wall Street, got beaten up even further as analysts downgraded their ratings on the stock after the company disclosed it was being investigated by the Securities and Exchange Commission.

At least a half-dozen investment banks issued reports Thursday with lower ratings on the stock, and most cited uncertainties surrounding the probe. Ironically, analysts were also disturbed by new operating information about the AOL division that they had been clamoring for.

AOL Time Warner was the most actively traded stock on the New York Stock Exchange Thursday. Share prices as much as 23 percent before closing down $1.76, a loss of over 15 percent, at $9.64.

The downgrades came a day after AOL Time Warner reported its second-quarter earnings, which came in ahead of expectations. On a call with investors, chief executive Richard Parsons disclosed that the SEC was conducting a preliminary inquiry into the accounting of several transactions that boosted revenues at the AOL division.

The transactions were reported last week in a series of articles in The Washington Post, which described them as "unconventional" ways of accounting for revenues. They included selling ads to a British entertainment company in lieu of taking a cash settlement in a legal dispute and booking sales from ads that were sold on behalf of eBay.

Parsons said the company stood by its accounting and that its auditors, Ernst & Young, had signed off on the transactions. Nonetheless, Parsons acknowledged that with concerns about accounting and corporate governance swirling in the marketplace, the company had to do more than merely follow the rules.

Parsons said he was "personally committed" to make the company more transparent to investors, and that AOL Time Warner would be disclosing more information to investors than it was legally required to. "The state of the market calls for it," he said.

While analysts didn't accuse the company of cooking its books, they said concerns about the inquiry would cloud the outlook for the stock. At least half a dozen downgraded their ratings on the company.

Salomon Smith Barney analyst Jill Krutick told investors said the probe added a new level of uncertainty about the stock, especially given "the current environment where rules can shift and political pressures run high."

"Any time accounting is an issue for an individual company, it's an issue for the company's stock price and for the overall market," said Tim Ghriskey, chief investment officer of money management firm Ghriskey Capital Partners.

Several analysts said the inquiry was unlikely to spread to the company's other divisions but said it would still weigh on the stock given the current market jitters.

"It's obviously a negative," said John Tinker, analyst at Blaylock & Partners. "But AOL's accounting issues have been around from Day One. No one has ever accused Time Warner of being overaggressive on their accounting."

Many of the transactions involved the AOL side of the company, which has run afoul of regulatory authorities in the past for aggressive accounting. In May 2000 the company agreed to pay a $3.5 million fine to settle SEC charges that it improperly accounted for costs to mail computer discs to potential customers.

In its earnings report, AOL Time Warner reported figures showing that the problems continued to be severe at its America Online division, a concern that has weighed heavily on the company in recent months. Advertising revenues tumbled 42 percent in the second quarter, and pretax earnings fell 27 percent.

Under pressure from investors, the company also provided more operating information about the AOL division, but many analysts didn't like what they saw. AOL revealed that its backlog of advertising, a key indicator of advertising demand, had fallen from $1.04 billion at the end of the March quarter to $860 million at the end of the June quarter.

Making matters worse, the flailing AOL division still has no leader. Chief operating officer Robert Pittman, a former AOL chief, had been dispatched in April to repair America Online. But he announced his resignation last week as part of a management shake-up.

One of the most serious issues confronting AOL is the maturing of its dial-up Internet service business and the slow conversion of its users to more profitable high-speed connections. AOL has yet to sign deals with major cable companies to carry its service, and other companies offering high-speed services are growing rapidly.

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