The Starting Line: EarthLink comes out a survivor

The company survived last year's Internet service provider wreckage to become one of the leaders in its industry. Wall Street has been paying attention.

4 min read
Remember EarthLink? If not, maybe you should, because Wall Street seems to have it in mind these days.

AOL Time Warner and MSN get most of the media attention paid to nationwide Internet service providers these days, but EarthLink has drawn the stock market's eye this year.

Shares of the third-largest ISP--at least measured by paying subscribers--have risen almost 170 percent since reaching an all-time closing low of $5.19 on Dec. 27. The Nasdaq composite index lost 33 percent in same period.

J.P. Morgan Securities analyst Paul Noglows is the latest Wall Street observer to tout EarthLink. Last week he started covering the stock with a "buy" advisory and a $20 price target. Noglows sees EarthLink as one of the biggest beneficiaries of cable Internet access. And the analyst sees EarthLink's 4.9 million-strong subscriber base as an audience that can draw the eye of a large communications company.

"The growing importance of online subscribers and EarthLink's position as the largest independent ISP makes it a highly strategic asset for many media and telecom companies that lack relationships with a large online audience," Noglows wrote.

He's not alone in his sentiments. According to earnings tracking firm First Call, the average brokerage recommendation for EarthLink is the equivalent of a "buy" rating. Other publicly traded, independent ISPs, including Juno Online Services, Prodigy Communications and NetZero, are ranked "hold"--when they're rated at all.

The change has come even though EarthLink's subscriber growth has slowed to a crawl and its largest shareholder seems to be bailing out.

Last year the company's customer base grew 50 percent; this year, analysts are looking for a single-digit increase in percentage terms, and virtually none at all from the third quarter to the fourth quarter.

And Sprint, EarthLink's biggest shareholder, is backing away. Sprint last month unveiled a public offering of 16 million EarthLink shares, although the phone company still owns the single-biggest portion of EarthLink. The sale announcement drove EarthLink's stock price lower, although it has recovered slightly.

Cynics would argue that the possibility of underwriting fees motivated several brokerages to curry favor with the company through "buy" ratings. But stock market movements aside, EarthLink, like almost all Internet companies, is moving from a "grow at all costs" mind-set to a "start making money" one.

EarthLink emerged as the final major player from last year's ISP wars, said Peter DeCaprio, analyst with Thomas Weisel Partners. Now it's reaping the benefits of being one of the only large, nationwide providers, including lower marketing costs and the ability to raise prices.

"The situation has changed almost completely from 2000 as the marketing battles have dissipated," said DeCaprio, who started covering EarthLink in July.

Time to buy?
Free ISPs and PC rebates tore through the Internet access industry last year, cutting into the profits and revenue growth of any ISP not named AOL. EarthLink's losses per share increased in the third and fourth quarters of fiscal 2000, as sales and marketing expenses more than quintupled from the second quarter to the fourth quarter.

Fortunately for EarthLink, fiscal sanity returned to the industry. Free Internet providers like Spinway.com and Freewwweb disappeared, and Juno and NetZero put limits on monthly access. MSN stopped its aggressive rebate program. And once the dust settled, AOL hiked prices.

EarthLink followed. Two months ago it increased its dial-up monthly fee to $21.95 from $19.95. And earlier this year, EarthLink boosted DSL fees by $10 a month. At the same time, the company is spending less on advertising and sales than last year. As a result, analysts expect EarthLink's operations to generate cash by the fourth quarter.

Not that EarthLink's wallet is hurting. The company ended the second quarter with $601 million in cash, and it had a relatively low burn rate--cash fell just $14 million from the first quarter.

That means EarthLink has plenty of money to buy smaller rivals; because of the economic downturn, dial-up subscribers can be picked up for a cheap price. There are plenty of them to buy; the United States has 5,000 to 9,000 commercial ISPs, DeCaprio said. "It's a great situation for EarthLink to be in," he said.

For example, EarthLink recently bought dial-up and DSL customer lists from Verado Holdings and its subsidiaries.

More important for future growth, EarthLink is one of the few national dial-up ISPs with an established foothold in high-speed access, thanks to deals with AOL and AT&T Broadband. Jefferies analyst Frederick Moran believes EarthLink will have at least 500,000 broadband subscribers by the end of this year.

In fact, given its solid dial-up base and growing high-speed business, EarthLink could just as easily be the acquiree instead of the acquirer. Several analysts believe it's only a matter of time before a larger communications company buys EarthLink.

"It literally could be any large communications company," DeCaprio said. "I don't understand why it hasn't happened already, to be honest with you."