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ISP eyes rural markets for profit growth

OneMain is aggressively buying small ISPs, a back-door strategy that could catapult it to profits and a big-league subscriber base, even if its markets are decidedly minor league.

The Central California town of Bakersfield isn't exactly a cutting-edge Internet market--and that's just the way OneMain likes it.

OneMain is one of the newest companies on a list of the country's largest Internet service providers. The firm has embarked on an ambitious acquisition strategy, scooping up small service providers in places like Bakersfield and other cities and towns.

It's a back-door See special feature: Main Street goes high tech strategy that analysts say is likely to catapult the company to profits and a big-league subscriber base, even if its markets are decidedly minor league.

"They're flying under the radar screen of a lot of ISPs who don't want to deal with hooking up someone in the middle of Montana," Forrester Research analyst Bruce Kasrel said. "It's a pretty solid model."

OneMain has spent the last year on a buying spree, snapping up 27 ISPs in places like Bakersfield, Bean Blossom, Ind., and Merritt Island, Fla. Its subscriber base has grown to about 650,000 subscribers, rivaling subscriber bases for services offered by telecommunication firms such as SBC Communications, BellSouth and Microsoft's WebTV.

Steve Smith, the company's chief executive and a former Morgan Stanley investment banker, says he plans to keep buying service providers until the middle of next year. By then, he says, the company should have reached about 1 million subscribers, given its current growth rate.

"That will give us the footprint and the revenue stream we need to start growing the business on an organic basis," Smith said. While the company loses only about 2.2 percent of its customers per month--a low "churn rate" by industry standards--the vast majority of its growth still comes through acquisitions rather than by signing new subscribers.

Smith's plan is to keep his ISP network focused on services for their individual local markets, but gradually move them to the OneMain brand in 2000.

That may be challenging, analysts say, as the company could risk losing the loyalty of local subscribers in an attempt to build its national brand.

"It would be the kiss of death for them to turn into the AOL for rural access," Kasrel said.

The company hopes to avoid this by creating "geographic communities" for each affiliate, essentially a local portal where customers can find links to Web shopping sites as well as the local high-school football schedule. In Bakersfield, for example, the local newspaper will be the centerpiece of the site, with classified ads, local news and local community information. The Bakersfield site is scheduled to launch in January.

The advantage of OneMain's strategy--and that of other independent ISPs in small markets around the country--is that it simply operates outside of urban and high-tech markets where most Net players are fighting tooth-and-nail for subscribers.

In larger U.S. cities, America Online, free ISPs like NetZero and independent national giants like the soon-to-merge EarthLink and MindSpring are fighting over dial-up subscribers. At the same time, telephone and cable companies are trying to persuade Net users to access the Net with their new high-speed technologies.

By contrast, 60 percent of OneMain's local markets can't even reach an America Online dial-up number without making an expensive toll call. Free access isn't available in many rural markets, and growing competition from high-speed Net companies is muted by the lack of modernized telephone and cable TV networks in these areas.

"We're insulated from most of that [competition]," Smith said. "We don't see that changing any time soon."

See related newsmaker: William Kennard Nor, for the most part, do the larger ISPs. It's expensive to serve smaller markets, and requires a different kind of marketing prowess, the companies say.

"Regional players will always do well as long as they stay regional," EarthLink spokeswoman Kirsten Kappos said. Her company would only enter smaller markets if its network partners, such as UUNet and Level 3 Communications, build into those areas, she said. And that doesn't appear to be happening any time soon, she added.

That lack of interest from the larger players preserves OneMain's subscriber base, but the company does suffer from a lack of choice in network providers.

Larger ISPs can send considerable amounts of traffic through partner backbone providers, and often can choose from a batch of competing providers for service. This has sent bandwidth costs down for the large ISPs, improving their collective bottom lines even as the firms' boost their national marketing budgets.

Smith concedes that his bandwidth costs are still high, but local phone companies are gradually bringing the costs down as OneMain collects more customers.

That's one of the things that has kept Wall Street lukewarm on the company's stock, which has remained in the high teens after hitting a high of 46.75 with its public offering last spring.

Nevertheless, some analysts believe the company is well-positioned to grab at least small profits typical of a well-run mom-and-pop ISPs, at least until these rural markets begin moving toward high-speed access provided by telephone companies.

"In the broadband world I'm not so sure. But the dial-up market is going to dominate for another three or four years," Kasrel said. "It makes a lot of sense for now."