EarthLink will have to spend more on marketing to keep up with the competition, something that could cut deep swaths into its earnings in 2002, analysts are saying.
Shares in the Internet access provider fell $1.67, or nearly 14 percent, to close at $10.30 Wednesday following a Goldman Sachs report that predicted EarthLink's earnings will suffer as it struggles to compete against leader America Online and second-runner Microsoft's MSN Internet access service.
EarthLink has been scrambling to convert its dial-up customers to the higher-margin broadband service and said it plans to convert as many subscribers as possible to cable in a move that will pit it against its biggest foe, AOL; the service would operate over AOL Time Warner's cable networks. Meanwhile, the company still depends on its base of dial-up subscribers, which is rapidly dwindling.
Noto expects EarthLink will lose around 50,000 to 100,000 subscribers in its "narrowband" or dial-up business for the fourth quarter, which will be offset by growth of around 65,000 subscribers in its broadband business.
That doesn't compare favorably to Microsoft's figures released Tuesday. The company said it added about 750,000 subscribers to MSN in its last quarter, drawing most of them away from AOL, which is still far ahead with 33 million subscribers to MSN's 7.7 million customers.
EarthLink, with 4.8 million subscribers, is by far a distant third. But Wall Street's biggest cause for concern is the company's slowing rate of subscriber acquisition.
Dwindling subscribers and "increased marketing in a competitive environment" will necessitate a big increase in spending for 2002, Noto predicted.
The company's slowing growth in relation to competitors indicates that "EarthLink will need to spend at a higher rate in 2002 to maintain its dial-up base while it trades subscribers to broadband," Noto said. The analyst expects the company will now spend around $20 million more, bringing sales and marketing expenses to $448 million, or 31 percent of its revenue in 2002.
That could take a toll on its earnings for 2002, said Noto, who now expects the company to bring in $80 million in earnings before interest, tax, depreciation and amortization (EBITDA), compared with the $100 million he had originally forecast.
"On the conference call for the third quarter, we did say sales and marketing would increase for the fourth quarter, but we didn't comment on 2002," said EarthLink spokesman Dan Greenfield. The company spent $94 million in sales and marketing in its third quarter. Greenfield declined to comment further on subscriber or marketing issues as the company is in a quiet period ahead of its earnings report Jan. 22.
But Wall Street is still upbeat on the stock overall. Noto rates it "attractive" and said the company is one of the most enticing opportunities in the new media sector.
Any increased marketing spending can be expected to pay off, one analyst said. "EarthLink's high-speed cable offering in 20 of Time Warner's cable markets and potential to increase marketing spending in these markets should help subscriber base rebound in 2002," said Jeffries analyst Frederick W. Moran.