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Net leaders merge to fend off competition

EarthLink and MindSpring merge amid an increasingly cutthroat market for Internet service providers, where it seems there is safety and survival in numbers.

In the increasingly cutthroat market for Internet service providers, it seems there is safety and survival in numbers.

Internet service providers EarthLink Networks and MindSpring Enterprises said today they would combine efforts, merging into a single $3 billion company with about 2.8 million subscribers.

It is the latest and largest deal in a consolidation trend that has reshaped the Internet service provider (ISP) industry over the last year. Small and mid-sized ISPs are facing growing pressure from larger players like America Online and other new Internet firms. The growing acceptance of free ISPs has also drawn potential subscribers away from paid services. To survive, the industry has spawned a number of business deals as firms join forces and combine subscriber lists.

Today's merger announcement met quick approval from most analysts, who said the two companies--now squarely ensconced in the market's No. 2 slot--are now better poised to take on the competition.

"This gets the thumbs up," said Joe Laszlo, an industry analyst with Jupiter Communications. "Given the threats from players like Microsoft Network, and their desire to take on AOL on its own terms, this [merger] seems like a literal pooling of interests."

Access isn't the only game
As free ISP services like AltaVista and NetZero and discount ISPs like Liberty Bay squeeze ISP profit margins, many companies have been looking for ways to save money and pull in new revenue sources.

Today's deal goes a long way toward doing that, providing the combined company with new access to marketing resources, savings on customer service and administrative costs, and better leverage to deal with network equipment providers, executives said.

"We can spend over $300 million in sales and marketing next year," said Greyson Hoberg, EarthLink's chief financial officer. "This gives us enough money to do the things we need to do to grow."

Significantly, the company will be able to stay in the black though this process, Hoberg said--a task that has proved difficult for EarthLink in its previous marketing campaigns.

But the merger also will increase the value of the firms' subscriber bases, analysts said. Both are seeking to gain market and advertising dollars by selling space on their customers' home pages--and analysts say that a single subscriber base of 3 million people is worth significantly more than two separate lists of 1.5 million.

"With ISPs, success is a matter of scale," said Marlowe Burke, an Internet analyst with Wit Capital. "The size of a company's subscriber base is extremely important in this market."

These new sources of revenue have for long been a serious goal for ISPs. They've watched companies like Yahoo reach profitability in large part on the basis of advertising and e-commerce dollars.

AOL has been the most successful in this regard, earning more than $4 per subscriber per month from its content and advertising efforts. EarthLink has been boosting the visibility of its Web page, earning about 60 cents per customer per month though advertising. MindSpring's revenue pull is closer to 40 cents per customer.

The companies see this ad push becoming a far more significant potential source of revenue when applied to their combined subscriber base.

"This is not a case where the incremental revenue is one plus one equals two," said Lance Weatherby, vice president of marketing for MindSpring. "The more customers we have in place, the more valuable they are."

No easy path
The combined company still will face strong pressures from larger firms like AT&T, Microsoft, AOL, and the local telephone companies, all of which are building up their Internet access businesses.

EarthLink and MindSpring each have made their reputation as relatively sophisticated services that provide top-quality customer support. Yet phone companies are scrambling to offer their customers new packages of phone service, Internet service, and wireless telephone use--a new idea that analysts expect to take off as consumers warm to the concept of bundled services.

As a pure ISP, the new EarthLink will not have the same flexibility as other telephone companies to provide bargains for other communications services as a part of a larger Internet package.

EarthLink does have another card up its sleeve, however. Long distance firm Sprint now owns 28 percent of EarthLink. After the merger, Sprint's holdings will fall to 14 percent, but the company maintains the option to return its stake to 28 percent within the next six months.

This relationship with one of the largest telephone companies in the United States gives the new EarthLink a steady stream of new customers, access to capital, and a critical link to other communications services such as high-speed Internet access.