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Q&A: Fernando Espuelas, CEO, StarMedia

When shares of StarMedia Network (Nasdaq: STRM) fell nearly 35 percent on Monday, the value of CEO Fernando Espuelas' holdings lost more than $100 million in value, which probably helps explain his eagerness to talk about his company's side of things after two major brokerages downgraded the stock.

Last week StarMedia told analysts it would boost spending this year, causing Merrill Lynch to cut StarMedia's near-term rating to "accumulate" from "buy" and Salomon Smith Barney to downgrade the stock to "neutral" from a "buy" recommendation, on worries that competition was forcing StarMedia to market more heavily than expected.

In a telephone conversation with ZDII, Espuelas said his company is doing as well as ever. Excerpts from the interview:

ZDII: On Friday, you told analysts StarMedia would be boosting some of its marketing for this year. Can you go into that a bit?

Espuelas: What we said we would be increasing our budget to deal with two major issues. One is acquisitions and amortization coming out of acquistion, and the rest would be marketing and new hires. in fact, about a third of the budget increase is non-cash accounting provision.

But in any case, what we did is, we said we're going to do is increase investment in three key markets: Mexico, the U.S. Hispanic market and our mobile business.

ZDII: Should Wall Street take that to mean that you might be putting off profitability to some extent?

Espuelas: No, absolutely not, and that's something that's been sort of lost in all this noise.

In fact, what we said is, it would in no way impact our profitability at the moment. In fact, there's an opportunity, although obviously we can't guarantee it, that we might actually be able to move up profitability one quarter.

ZDII: What are you looking at then for that?

Espuelas: The consensus estimate from Wall Street is that we would be cash flow positive the last quarter of 2002, and we're absolutely not moving away from that. In fact, we feel even more confident that we will reach it, so much so that there is an opportunity to come in cash flow positive third quarter (of 2002).

ZDII: Judging by the stuff on the wires today, people are sort of worried about increasing competition. That was cited in the Salomon Smith Barney report. Certainly that's been a worry not just in Latin America, but even in the U.S. -- ISPs are all being dogged by competitive issues. Why shouldn't people worry about that in your case?

Espuelas: Remember that we're not an ISP, just as sort of an aside.

I'm not saying we don't worry about competition, we worry about it every single day. However, we are really far ahead. We're far ahead in all the metrics that matter for this business. We're far ahead in capturing audience. We're far ahead in our sales. In fact, if you look at our 1999 sales, we sold more than all of our competitors combined.

And we believe that by having been the first mover; by having made the investments that we made when we made them in our brand, in our product, in our local infrastructure, that in fact what we have is a platform that will be profitable on time; a platform that will overwhelm its competitors as it has done in the past; and a company that is very well positioned to continue to not just maintain our leadership but really expand it as time as goes by.

ZDII: StarMedia has a fledgling ISP business, does it not?

Espuelas: No, we have, in fact, almost no ISP business. Less than 1 percent of our traffic comes from direct ISP connections, and much, much less than 1 percent of our sales comes from that.

In fact, what we are is the leading media company on the Internet for Spanish and Portuguese markets. Meaning that our model, like any media model, has enormous operating leverage in it, and we do not have the costs of infrastructure that go along with an increase in size of an ISP business.

ZDII: The reason why I bring that up is because that was mentioned in the Salomon report. The analyst seemed rather concerned about the encroachment of free ISPs.

Espuelas: Yeah, I think there was a bit of a misunderstanding. Our free ISP business, the way we structured that deal, is meant to minimize our capital contributions. Our primary investment in that business is through a dedicated version of StarMedia that will be the front end of that ISP.

ZDII: So you don't see the ISP as a revenue generator, more like another doorway to your network?

Espuelas: It actually will be a revenue generator. The way we did it -- and this is very different from what our competitors have done -- is we put the free ISP as a separate, stand-alone company, of which we will own a minority stake in it, so that we do not expect to have any losses accumulate beyond our initial investment.

With this company, we have a contractual agreement: in exchange for them using the StarMedia brand, and the StarMedia portal and our sales force, we expect to have revenue generated.

But beyond that, what it is, is a very powerful platform to distribute StarMedia products, which in turn, beyond our relationship with this ISP company, allow us to generate incremental revenues from advertisers and e-commerce partners, and of course, generate incremental traffic through this platform.

So what we are projecting in terms of the increase in our budget really is not at all connected to that.

ZDII: You don't have too many Nasdaq-traded competitors, Terra Networks (Nasdaq: TRRA) and El Sitio (Nasdaq: LCTO) come to mind. The issues raised in the analyst reports are rather general, why do you think your peers aren't being hit as hard as you are today?

Espuelas: I've long ago given up on trying to understand what the market is doing on any particular day.

And by the way, I should give you a little bit of context. We're covered about 10 major analysts on Wall Street, all of whom and many others were present on the call. So, two out of ten, it's unfortunate that they reacted negatively, but nevertheless, most of them reacted positively, in fact.

But net-net, to answer your question, the comments were specific to us, so you would expect it would impact us more than anybody else. But if you look at their stock prices, today they're being beaten down in this downdraft as well.

Believe me, as a major shareholder in this company, this is not a happy moment. But at the same time, we're not running a stock, we're running a company. And we're making the decisions that we know lead to the build-up of a very strong franchise of a profitable company. We feel very good about the business, the business is doing very, very well.

ZDII: What do you think it will take to turn around Wall Street's sentiment, at least at the moment?

Espuelas: Well, you know what, I don't know about today or tomorrow. Today, I imagine nothing will resolve that, since there's a clear sentiment. But what we have to do tomorrow and the day after that is continue to execute on the business.

As I said, we're not focused on today, we're really focused on the future. We know we will get to profitability on schedule, and that's the key point. How we get there is a function of the management technique or the strategy we want to apply.

And we're very comfortable with our strategy. Otherwise, we wouldn't have outsold every single competitor, and had more traffic than all of our competitors combined. So we know we're in the right business, we know we have the right strategy, we have the right investments in place that will allow us to continue to exceed expectations hopefully into the future. And I think when people see our Q1 and other quarters into the future, I think people will understand why we do what we do.>