In the aftermath of EarthLink's strategy alteration with long-distance giant Sprint, several signs point to a possible partnership between Microsoft Network's dial-up Internet access service and the company. Industry analysts say a tie-up could behoove both companies in their battles with online titan AOL Time Warner.
Microsoft has spent heavily to close the gap between its 4 million-subscriber-strong MSN service and America Online, the world's largest ISP. A pact with EarthLink would more than double MSN's customer base. For EarthLink, Microsoft's involvement could offer more credibility with consumers, greater access to PC maker partnerships, and promotional power.
"When you look at AOL with 27 million customers worldwide and you look at No. 2 and No. 3, they're a long ways back," said Alan Mosher, an ISP analyst with industry consultants Probe Research. "The only way you can start to compete effectively is to grow quickly. By combining No. 2 and No. 3 together you start to become more attractive to advertisers and e-commerce companies."
AOL's incredible subscriber growth and the close of its merger with Time Warner poise the company for further expansion into high-speed Net access, which is expected to be the industry's next area of growth. It is already the clear leader in Internet brand awareness among consumers and commands a significant portion of online advertising and e-commerce dollars.
The donnybrook in recent years among second-tier ISPs, such as EarthLink, MSN, Juno Online Services, AT&T WorldNet and NetZero, a free provider, has done little to establish a clear-cut challenger to AOL's supremacy. But a partnership, or even a merger, between two of the next-largest players could change all that.
Rumors in the air
Citing a number of factors, some analysts believe a deal between MSN and EarthLink is not just a possibility but a likelihood.
"Based on several recent developments, we believe a strategic transaction between EarthLink and Microsoft may be imminent," Frederick Moran, an equity analyst at Jefferies & Co., said in a research report last week.
Specifically, Microsoft recently ended its $400 rebate offer for new Internet access customers. The program helped attract customers, but at a cost to Microsoft's bottom line. A deal with EarthLink would quickly more than double MSN's subscriber totals without the need for costly rebates or other marketing programs, Moran contends. EarthLink has 4.7 million subscribers, second only to AOL Time Warner in terms of paying customers.
Additionally, Moran believes recent changes to EarthLink's partnership with Sprint were made with a third-party acquisition or partnership in mind.
Microsoft executives dismissed rumors of a deal with EarthLink. "We are not actively pursuing any particular deal with EarthLink at this time," said Bob Visse, group product manager for MSN. "No, we're not going to buy EarthLink. There's no deal imminent. There are no active talks in that regard."
EarthLink representatives declined to comment specifically on the rumors of a deal with MSN, but did add some insight into the changes in its pact with Sprint.
"The Sprint deal definitely opens doors that were closed before," said an EarthLink spokesman. "This allows us to talk to people that wouldn't have talked with us before because they thought we were sort of married to Sprint. There were a lot of governance things that intimidated a lot of people. Now they're all gone."
Why a deal makes sense--to some
For Microsoft's part, the software company was notoriously late to the Internet party and has spent years and millions of dollars playing catch-up.
"They've dumped a ton of money into trying to become another AOL and they're nowhere near that," Probe's Mosher said.
An acquisition of EarthLink would
Gartner analyst Lydia Leong says a combination of EarthLink and MSN might not result in a whole that is greater than the sum of its parts, though, unless Microsoft rethinks its Internet access strategy.
But other analysts doubt EarthLink management would be willing to sell, and certainly not for a price lower than the mid-$20s per share. "I don't buy it," said Jeff Sadler, an equity analyst at FAC/Equities. "I think EarthLink is more of an acquirer than an acquiree."
Citing market speculation rather than sound fundamentals, Sadler cut his rating on EarthLink to "neutral" from "buy" after EarthLink shares gained about 30 percent from late last week.
EarthLink says its strategy is to continue offering not only dial-up Internet access--selling that access on a wholesale basis to other providers--but also broadband and wireless options.
For one, there is no love lost between Microsoft and AOL. But EarthLink has a cable access deal with AOL Time Warner that would allow the ISP to deliver high-speed Net access via cable modems. It is unclear how that pact might be affected by an acquisition of EarthLink.
Second, Sprint, though it no longer has seats on EarthLink's board of directors, owns a 27 percent stake in the ISP and has the right to refuse any acquisition offers for EarthLink.
Some analysts believe the plethora of competitors with low stock prices and foundering free ISPs could present EarthLink with an opportunity to buy a rival for a song. Other industry watchers suggest EarthLink could benefit from a new deep-pocketed partner.
"It's more imperative to EarthLink than to Microsoft. MSN's got the whole of Microsoft behind it; I don't think EarthLink has those kinds of options," Mosher said. "I also think that MSN's got good consumer brand awareness. I think EarthLink would gain visibility if they got together.
"I don't think EarthLink has the kind of money to do the types of things Microsoft can do," he said.