2HRS2GO: Earthlink investors remain chilled

5 min read

COMMENTARY -- Someone ought to tell Earthlink (Nasdaq: ELNK) to adjust its notion of What's Hot.

To be sure, I can't disagree with everything in the Hot list on Earthlink's website. DSL is definitely hot. Jobs are always hot. Personalized home pages are sort of hot, though not as hot as they were a year ago. Contests can be hot, especially if you win. I suppose Web hosting and better Internet access software qualify as at least warm.

But Investor Relations? Sorry, but few things are colder than Earthlink's stock:

ELNK has shed nearly 80 percent of its market cap over the past year, far more than rival America Online (NYSE: AOL). That trend didn't change today, as shares Earthlink dipped 0.0625 to 6.6875 this morning after the Internet service provider's third quarter report.

A comparison to AOL might seem unfair, because nobody could reasonably be expected to rival Steve Case's juggernaut. Except that Earthlink once upon a time figured on doing just that.

Recall Earthlink's conference call last year to announce the company's merger with Mindspring Enterprises. Michael McQuary -- then president of Mindspring and now holding the same title with Earthlink -- crowed:

"This is a two horse race. I think there will be some people wetting their pants in Virginia. Frankly I'm so excited I may wet mine."

Hope he saved those stained slacks, so the smell can remind him of how Earthlink has fallen short of its lofty goal. In the last 12 months, America Online has grown bigger and more entrenched in the top ISP spot, and despite the weighty concerns surrounding the Time Warner (NYSE: TWX) merger, AOL stock remains far more stable than ELNK.

AOL continues to add huge chunks to its user base, including 1.4 million new users in the September quarter. Meanwhile, Earthlink has abandoned all hopes of growth among dial-up subscribers.

Earthlink, which ended September with 4.6 million users, now expects its total customer base to range between 4.7 million and 4.8 million at the end of the year, which would be at least 200,000 short of the company's original goal of 5 million. Earthlink anticipates an additional 65,000 broadband customers in the fourth quarter, so Earthlink doesn't expect to get more than 35,000 new dial-up users in three months. AOL signs up more than that in three days.

America Online and MSN simply have deeper wallets. They can subsidize $400 rebates on new PCs in exchange for three years of ISP service. Earthlink has no chance of matching that.

"Until we see some change in the market, we can't afford to pay $250 on a marginal max for a dial-up subscriber," Betty told analysts today.

To Earthlink's credit, it's attracting DSL customers at a strong clip, and is now the second largest non-Baby Bell provider of broadband service in the United States, behind Excite@Home (Nasdaq: ATHM).

Yet all that does is make up for Earthlink's disappointing performance in the narrowband world. Even with broadband growth, the company's financial targets remain essentially the same, perhaps even a little worse in the near term: Earthlink now says increased marketing for broadband will result in a fourth quarter loss ranging between 48 cents and 53 cents per share, compared to First Call consensus that was predicting a deficit of 49 cents per share for the December period.

Whether Earthlink can maintain its DSL strength also remains to be proven. Ultimately, Earthlink will face the same problems that plague it in the dial-up, as competition becomes fiercer and larger, better capitalized players emerge. Earthlink has already admitted it can't match the pockets of AOL and Microsoft (Nasdaq: MSFT), and it's only going to get worse with DSL. Forget $400 rebates -- the Pacific Bell subsidiary of SBC Communications (NYSE: SBC) is offering a free PC in exchange for a two-year DSL subscription.

Other companies such as Juno Online (Nasdaq: JWEB) have their own plans for DSL and cable Internet. I've seen Juno ads on TV quite a bit lately, and I doubt it will ease up on its own marketing anytime soon.

And what will Earthlink do when MSN and AOL get their broadband acts together? America Online already has a reseller deal for the DSL service of Verizon (NYSE: VRZ), and assuming the Time Warner merger closes as expected, AOL cable modems won't be far away. Of course, don't forget about that old bundling problem -- if MSN and AOL can do it in dial-up, they surely can do it in DSL at some point.

Earthlink already feels the need for some aggressive tactics. Broadband revenue growth trailed the subscriber expansion rate in the third quarter, executives said, because Earthlink relied on a 3-for-1 promotion.

Company executives expect that by the second half of next year, Earthlink will generate a profit before interest, taxes, depreciation and writeoffs, as the company focuses on broadband and boosts margins. I'm willing to take them at their word.

Profitability is a matter of running the business you have in the best fashion possible. Becoming profitable while expanding that business rapidly -- that's another question. America Online is the only ISP to do that so far, and AOL -- which isn't a pure ISP anyway -- had the luxury of a more patient market back in the 1980s and early 1990s.

That's not the case these days, even with Wall Street's slump this year. If ELNK is ever to bounce back to a decent price while Earthlink remains independent, investors need to hear about dramatic growth on both the bottom and top lines. They weren't hearing enough of it this morning. 22GO

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