SOURCE: Copyright Parish & Company.  Preliminary report, please send comments to bill@billparish.com

Microsoft Collapses AOL Time Warner - Part II, Parish & Company Requests FTC Inquiry

PORTLAND, Ore., April 30, 2001   The long-standing competitive duel between AOL and Microsoft does now appear to be over.  The only remaining question is which media outlet will report how AOL has failed and how significant investor losses will be given that AOL has a market value in excess of $200 billion, in addition to having more than $20 billion in bonds outstanding.

Janus alone owns more almost 5 percent of the company. AOL has also become one of the top 10 holdings in most public pension funds and therefore all taxpayers will be indirectly impacted.  These public pensions are mostly indexing off the S&P 500 and AOL, through its use of financial engineering, leveraged its stock to represent almost 2 percent of the entire S&P 500 Index.

It is important, however, to know that AOL is an "effect" of the financial engineering occurring at the Microsoft Corporation.  This situation has allowed Microsoft to erect a pyramid scheme that has already destabilized the global economy and U.S. stock market.  It has also now marginalized its only two strong remaining internet portal competitors, AOL and Yahoo.  Microsoft is in fact now poised to put the overall U.S. economy at risk in a desperate attempt to sustain its pyramid scheme for reasons outlined in this report.

In part I of this series on AOL, see part I, we saw that AOL assumed more than $20 billion in bank debt, a back tax bill of $16 billion and $10 billion in stock option debt upon purchasing Time Warner.  Combined, these obligations exceed gross annual revenues. In addition, AOL now has annual interest charges on its debt of close to $2 billion.  Remarkably, AOL is still issuing more bonds and these bonds are rated as investment grade by Moody's and other top bond rating agencies.

AOL simply forgot that success in pyramid schemes is all about generating cash and transferring this cash from new investors to old investors.  In Time Warner's case, the transfer went in reverse and, as explained in part I, will leave AOL with insufficient cash to extend its business model.  Also detailed in part I is the striking similarity between AOL and California's largest utility, PG&E.

Investors often complain that "there was no sign" of a pending problem at a troubled company yet these reports clearly outline AOL's yet to be disclosed dilemma.  Microsoft has effectively placed AOL in a mathematical financial vice offering no escape.

Those of you familiar with my reports know that they are used by a large number of leading reporters and analysts, rarely with attribution.  You also know that you will see a few typos yet the content is unique and of the highest quality.  As an investment advisor and genuine believer in the merits of a strong free market system, complete with adequate regulatory oversight, I am simply astonished that the NY Times and other leading business media organizations have steadfastly refused to disclose the nature of this scheme, unique to and erected by Microsoft.  These news organizations are an integral part of our free market system.

Let's now look at a few significant recent events.
 

1) Microsoft Uses Qwest, Parent of US West, To Marginalize AOL in 14 Western States

One need only look at Microsoft s recent deal signed with Qwest and how it will impact AOL. In this deal all of Qwest's high speed and dial-up customers will be required to convert to MSN this summer.  Since Qwest owns US West, the former regional bell operator, this will give Microsoft a de facto monopoly over the provision of DSL service in 14 western states.  This is important because DSL is usually offered in the highest density most profitable locations.

This leaves AOL competing for the outlying less dense areas with significant infrastructure costs. Although AOL's cable system is believed to be a good high speed solution, it is also facing a strong looming competitor in the form of high speed satellite access within 18 months.

It is perhaps also noteworthy that Craig Barrett, Intel CEO, is on the Board of Directors at Qwest.  Mr. Barrett has been strangely silent on many important issues important to the proliferation of the Internet, most notably privacy.

2) Microsoft's Scheme Leaves Qwest Cash Poor and Willing to Exclude AOL and Other Providers

Like most telecom companies struggling with massive debts, Qwest desperately needs cash flow in order to build out its network.  This is a remarkable aspect of Microsoft's scheme, see part I, since they are able to generate cash when most of their competitors using the same techniques cannot.  This cash is now being deployed to effectively take over key segments of the telecom industry in order to further proliferate Microsoft's product based monopoly.  And while Intel and others continue their relentless pursuit of higher quality at lower prices, Microsoft continues to charge egregious prices.  One need only visit Office Depot, a quality discounter, to see that these prices for Microsoft software now exceed the cost of most new computers.

What triggered this cash weakness in the telecom sector was Cisco Systems monopoly over data transmission equipment, at one time Cisco had a 90 percent market share.  In its desperate attempt to keep Microsoft at bay and prevent being reduced to a commoditized hardware vendor like Intel, Cisco charged ridiculously high prices for years and forced most telecom companies deeply into debt in order to build out their data networks.  These profits were then used to inflate Cisco's stock price and the stock then used as a merger tool.  This merger tool was very effective in blocking out new low cost competitors that could have dramatically reduced prices for telecom data equipment. Cisco was buying more than 20 large companies in some years, many exclusively software, using the pooling loophole, see Cisco Watered stock report, in a desperate attempt to keep Microsoft at bay.  Of course Cisco failed and left the telecom industry deeply in debt.

Business Week recently did a major story based upon my Cisco study, without attribution, that likened the telecom situation to the Savings and Loan banks.  The first email I sent out after Microsoft told PR Newswire to stop issuing my press releases in November, 1998 was titled "Charles Keating, Bill Gates and your 401K."  Even today, two years later, a major publication like Business Week still can't conceptualize this situation accurately.  Perhaps this is the down side of using someone else's research without the benefit of discussing it with the author, in this case me.

Although there are similarities to the S&L situation in the telecom companies themselves, the real similarity is that the public pensions have been pilfered by Microsoft and others trying to emulate Microsoft, most notably Cisco Systems, due to these pensions excessive reliance on investment based upon the S&P 500 Index.  See Microsoft Pyramid summary for how this occurs.

3) Parish & Company Launches Effort To Block Qwest/Microsoft Deal, Cites Hart Scott Rodino "Tie-In" Anti-Trust Violation

Parish & Company today formally opposed this agreement between Microsoft and Qwest to the FTC because it is a violation of the Hart Scott Rodino Act.  Specifically, it is a textbook example of a tie-in monopoly strategy.  Microsoft did also have an equity interest in Qwest prior to the announcement.  Microsoft should be prohibited from these deals until such time that MSN is separated from the product side that is generating tax free monopoly based profits.

Also included in the deal is Qwest's commitment to do $100 million in advertising on MSN, a bartered transaction that allows Microsoft to manipulate its gross revenues, and thereby its stock price.

Please do also consider writing the FTC yourself.  This is a watershed event.  Any group concerned about Microsoft's business practices, i.e. Linux, etc. should very aggressively oppose this deal and seek legal counsel to help defeat it.  It should also now be obvious that business reporters themselves will be among the biggest losers in MIcrosoft's scheme as unproductive mergers by media companies resulting in layoffs are undertaken in a futile effort to cut costs and compete for capital with the scheme.

4) Judge Jackson Publicly Concedes Defeat in the Anti-Trust Trial

Many were shocked when Judge Jackson agreed to an interview after the DOJ trial and referred to Bill Gates as a megalomaniac and likened Microsoft's business practices to those of narco trafficers.  What Jackson was really doing is implementing the only remedy reasonable given the political nature of this trial and inevitable hand slapping that will occur from the appeals court.

By Jackson publicly disparaging Microsoft, he clearly awakened a large section of the public to their business practices and severely damaged Microsoft's public credibility.  Jackson was after all appointed by Ronald Reagan and has consistently been pro business on most significant cases.

5) How Microsoft's Bartered Sales Generate Cash and AOL's Do Not
By bartering to manipulate gross revenues, Microsoft can thereby inflate its stock price.  As its stock inflates, this correspondingly increases the gains recognized when employees exercise options.  These gains to employees are W-2 wages and correspondingly valuable tax deductions to Microsoft.  These tax deductions create valuable cash in the form of non-payment of federal income tax.  Since AOL doesn't have adequate net income to fully utilize its tax deductions, see part I, these bartered transactions inflate the stock price but do not generate cash.

SEC's Warrants for Revenue Hunt Is On by Joe Bousquin of Thestreet.com, April 27, 2001
In this article Bousquin notes that Purchase Pro has "issued warrants to strategic partners such as AOL."  The key point here is that Microsoft's pyramid has enabled it to create a large cash machine.  That is why they have more than $20 billion in cash and AOL is instead issuing bonds to cover operating costs because a sizable portion of AOL's sales appear to be bartered non cash transactions. If these non cash sales are significant at AOL, as I believe, they could expose AOL's auditors to substantial legal liability for not adequately disclosing this fact to investors.

5.5)  Microsoft Milks Pentagon and Public Pension System Simultaneously, AOL Restricted to Pension System
This is an important distinction given that the Pentagon is now Microsoft's largest customer.  These are significant cash sales while AOL is instead selling privacy to advertisers in its "walled garden," often times bartered transactions in which no cash is generated.  Even more striking is that Microsoft is generating tax free profits from its sales to the pentagon.

Bill Gates personal investment portfolio is also making significant inroads into defense procurement which will allow him further leverage in deploying Windows based products in key government agencies.  One good example of the tax-free profits laundered into defense contractors is General Dynamics recent purchase of Newport News Shipbuilding.  This link confirms that Bill Gates is the largest shareholder of Newport News Shipbuilding, note that Michael Larson heads Gates' investment company.  Since this is a cash offer, it appears that Gates must now find a new place to launder the profits from Microsoft's monopoly. This shouldn't be too painful given the significant profit he earned on the Newport investment.

Meanwhile, AOL is entering into partnerships with a wide mix of advertisers boasting about how many eyeballs it can sell.  A business which they will soon discover has rapidly diminishing incremental returns.

The brilliance of Microsoft's financial scheme is probably not going unnoticed at the Pentagon as Microsoft and Bill Gates are creating a de facto form of governmental control.  Is it not odd that Microsoft's largest customer is the Pentagon and that last year the company earned almost $10 billion in net profit and paid no federal income tax on those sales?   Of course Microsoft's scheme is not only crushing AOL but also posing a national defense issue given that this distortion introduced by Microsoft will put severe downward pressure on future government tax receipts, directly impacting the Pentagon's ability to finance future projects.

On the product side, there are also numerous serious issues regarding the integrity of Microsoft's products.  Can we really afford to have key defense systems running in such an unstable environment?  Sadly, this monopoly may also be allowing many foreign governments to implement more stable systems and extend a level of intelligence far beyond our own.

The obvious question becomes, why didn't the NY Times and other leading financial publications disclose Bill Gates involvement with Newport when the General Dynamics deal was announced, given that the Pentagon is Microsoft's largest customer?  The answer is obvious, poor sources due to an unwillingness to cite independent analysts like myself.

Although without significant government sales, AOL is now able to pilfer the pension system, as has Microsoft, given that it is roughly 2 percent of the S&P 500 after its merger with Time Warner.  This means that roughly 2 cents of every dollar dedicated to stocks in public employees retirement is going to the purchase of AOL, given that most public pensions are indexing off the S&P 500.  In AOL's case this will be a short-lived phenomena since they don't have the government sales Microsoft does, sales that will stabilize Microsoft's revenue base and allow them to fleece key government agencies with overpriced monopoly based products, in addition to pilfering the public pension system.

6) New SEC Chairman To Be Nominated, by Kathleen Day of the Washington Post, April 27, 2001
This is a link to Harvey Pitt's Home page at the law firm of Fried, Frank, Harris, Shriver & Jacobsen.  Mr. Pitt was at attorney for the SEC in the 1970's.  He later became a defense lawyer for large investment and big 5 accounting firms in addition to various investment professionals charged with fraud by the SEC, including the legendary Ivan Boesky.

Given Mr. Pitt's experience defending those charged with fraud, he does appear eminently qualified to tackle this most difficult role and complete the important agenda established by his predecessor Arthur Levitt. Mr. Levitt has indeed endorsed Mr. Pitt as an outstanding candidate and therefore parish & Company also strongly supports his candidacy.

This will be a difficult switch for Mr. Pitt to make yet will also provide him an opportunity to make contributions that could be of historical significance with respect to restoring integrity to the financial reporting process.  I have already contacted Mr. Pitt and will be submitting the specifics regarding a case for financial fraud against both Microsoft and Cisco Systems and their auditor in the event Microsoft is unwilling to compromise, prior to Mr. Pitts Senate confirmation hearing.
 
7) Microsoft Manipulates The Federal Reserve Bank as The Bank Hastens AOL's Demise

That statement itself would seem patently absurd yet as the English say, this conclusion is "spot on."  Let's examine the mechanics.  First of all, we know that as Microsoft inflates its stock price they are effectively inflating the speed at which employees prepay their wages in the form of stock option gains.  These gains to employees that they will owe tax on at ordinary rates are valuable tax deductions that generate cash in the form of lower federal income tax on product profits.  Microsoft also gets to pocket the exercise price paid by employees to take ownership of the stock.

This explains why Microsoft now pays no federal income tax, as uncovered in a previous study that the San Francisco Chronicle used without attribution, a story that was globally syndicated and appeared in the WSJ and other leading publications.
 
How Microsoft Made The Federal Reserve a Key Component in Its Pyramid Scheme.
The primary role of the Federal Reserve Bank is to manage the money supply.  This occurs via interest rate policy and its corresponding impact on the availability of credit.  What the Federal Reserve has failed to see is that stock option wages  manufactured at Microsoft have grossly inflated the money supply yet are not reflected in the official statistics.  Such options have also been significant at AOL yet AOL is now in midst of a cash squeeze.

The Federal Reserve has made too many rate changes in recent years and these have collectively sewn the seeds of "external inflation", as explained in the first AOL report.

8) AOL Manipulates the Business Press, Furthur Fueling Microsoft Pyramid Scheme.

In AOL's recently announced quarterly earnings statement the focus was EBITDA or earnings before interest, taxes and depreciation.  There were also several references to cash earnings as the company boasted of record growth in cash flow. Remarkably, these press releases were echoed in leading publications such as the NY Times with almost no analysis.

It's as if these companies are using the Times and other outlets as a conduit for financial deception.  This again highlights the problem at the Times and why so many stories are just plain not accurate, the problem being their failure to cite independent sources who do not maintain the conflicts of interest their most common sources maintain.

Although AOL shareholders may receive a short-term benefit from AOL inflating its stock price, this inflated value does not create cash as it does at Microsoft for reasons explained in Part I.  

In a curious aside, the NY Times has changed its archive database structure and it is now very difficult to find the one article in which they referenced my work.  Previously, inputting Bill Parish in the search resulted in one story being selected and now more than two hundred are selected, none of which have the complete term "Bill Parish."  A similar search for Bill Gates and other names does not generate the same difficulty.  This is not to say that someone at the NY Times is making it more difficult to find the article based upon my study but rather to alert readers regarding the infinite possibilities for manipulation with respect to how databases are "keyed."  It is very easy to make finding certain information difficult without drawing attention, if that were indeed one's intention at the NY Times.

9)  In Desperation, Yahoo Builds Pornography Business and Censures Bill Parish's AOL Report
Frankly, I could not believe that Yahoo had censured my first AOL report yet that is true.  After receiving numerous emails, I tried to post a link to the report on a yahoo message board and the message was automatically removed.  You may test this yourself by posting a message on Yahoo with the following link:  http://www.billparish.com/20010404americaonline.html

One might ask, what would cause Yahoo to impair its reputation and future credibility by censuring top quality independent financial research.  Yahoo also recently implemented a new policy barring reporters from financial meetings unless they are shareholders. Clearly, this desperation is rooted in a failure to compete with the Microsoft Corporation's pyramid scheme.  Yahoo recently became so desperate that it looked to pornography, later publicly discontinuing this effort due to an outcry from users.  Even worse Yahoo is now censuring reports like mine under the guise of "message board policies" in an effort to please major advertisers.

As you all know, my information and conclusions are based upon SEC filings, filings so long and complicated that even top CPA's no longer understand them.  By censuring my clear well referenced interpretations of these SEC reports Yahoo is really censuring the SEC itself.  This does not necessarily mean that they are colluding with Microsoft and AOL to price fix their stocks yet it does raise some interesting questions.

10) Parish & Company Offers Yahoo Some Free Advice on How to Survive
Wake up!  Forget today and think about tomorrow. You have a lot of brilliant people but to expect them to compromise themselves and adopt an AOL like total breakdown in integrity is not realistic.  The best people will leave and you will be left with nothing. The answer is simple.  Charge a flat monthly fee to all users and include a variety of products and services to justify such a fee.  Most important would be strong privacy protections in which users who pay this fee would be guaranteed that Doubleclick and others would not be allowed to compile user data if you pay the $5 per month.  You have a good email service, good chat feature and lots of great on line communities.

As one of three key portals, you should also be able to justify charging this fee.  Being totally dependant on what you call advertising, yet what is really a shameful sale of privacy, only serves to dumb down the value of your service.  As your CEO Koogle notes "the shake-out of Internet portal sites is complete and has left Yahoo with only two global competitors, AOL Time-Warner and Microsoft."   It is my sincere belief that failure to implement this strategy correctly will result in Yahoo's demise and ultimate sale to another company, probably within 12 months.

Mr. Koogle, as with AOL, has failed to see that using some of Microsoft's same techniques, in particular the excessive issuance of non qualified stock options, is a cash drain on the equity base rather than the money tree it is at Microsoft, see the first AOL report for an explanation.  This drain occurs as employees pay tax on options exercised and these amounts are permanently extracted from the equity base and transferred to the government.  In Microsoft's case, this situation is mostly a "wash" because the company is fully utilizing the tax deductions as an offset to operating profits, that is, there is no permanent extraction from the equity base.

In plain terms, this means that both AOL and Yahoo are issuing too many options in order to compete with Microsoft and this dilutes their equity base, in real cash terms, making secondary equity offerings or debt issuance needed for expansion unrealistic.  AOL may be getting away with issuing bonds while the business press sleeps now yet that spigot will close very quickly once this situation is disclosed.

AOL will also want to compare itself to other media companies such as Viacom and Disney, saying look at the debt they have.  The difference is that AOL's primary business is as an Internet portal and its primary competitor is Microsoft, a company with no debt and more than $20 billion in cash resulting from a most successful yet, even today two years after publishing my original report, not fully disclosed pyramid scheme.

Please visit my forum if you have comments to contribute on this report at Bill's Forum.  Your comments are most appreciated.
 

Parish & Company is an independent fee based investment advisor to individuals, pensions and trusts based in Portland, Oregon.  No fees are accepted, either directly or indirectly, from any provider of investment products.