Earthlink Needs a Lifeline
The onetime high-flying ISP is running out of options as customers abandon dial-up services for faster ways to get online
by Olga Kharif
The advent of broadband has not been kind to companies like Earthlink (ELNK) and Time Warner's (TWX) AOL that built their businesses on providing dial-up Internet access. Both former high-fliers have been forced in recent years to change tack and focus on new areas of growth as customers flock to competitors offering faster ways to get online. The trouble is, not all those new businesses are panning out—especially for Earthlink.
On Aug. 29, Earthlink Chief Executive Rolla Huff conceded that some of the company's pursuits, including an ambitious plan to help cities provide low-cost wireless Internet access, were not performing to plan and that it would scale back struggling businesses. A day earlier, Earthlink said it was cutting 900 jobs, or about 40% of the workforce, and shuttering several offices. The restructuring should help the company generate $135 million to $145 million in cash from operations this year, and $200 million in cash from operations in 2008. (Earthlink still expects a net loss of $79 million to $109 million this year.)
Retrenching Mode
The initial response to the moves was positive. "They are right to pull back" on businesses such as municipal Wi-Fi, says Doug Williams, a JupiterResearch analyst. Securities firms including Channel Mark Capital upgraded the company's shares to "buy." Earthlink stock surged 11%, to $7.62.
But it may be too early to uncork the champagne. Earthlink's existing businesses remain under pressure, and it's given little indication where it will look for growth next. Compared with a year earlier, the company shed 177,000 customers, and sales dropped 6%, to $312.2 million, in the second quarter. "We are spending a lot of time on considering our alternatives," Huff said. Those include anything from investing in new growth opportunities to returning cash to shareholders.
There's no single, easy-to-chart path to growth, and it's not clear Earthlink will be able to continue as an independent business. "They are just trying to staunch the bleeding," says Sally Cohen, an analyst at Forrester Research (FORR).
Hindered by Helio
While costly Wi-Fi projects are being scaled back, another new business, the Helio wireless joint venture with SK Telecom, will remain a drag on Earthlink's financials. Helio had losses of $83.8 million in the second quarter alone. Earthlink, which had $383.4 million in cash at the end of June, is on the hook for as much as $100 million for Helio. Earthlink still plans to spend $40 million to $50 million to finish its muni Wi-Fi projects in Philadelphia; Corpus Christi, Tex.; and Anaheim, Calif.
And rather than aggressively marketing to new users, Earthlink plans to focus on keeping existing subscribers from jumping ship to rivals such as Verizon (VZ) and Comcast (CMCSA). Earthlink would like to see its roughly 3 million dial-up subscribers convert to faster Digital Subscriber Line service. Earthlink has about 1.1 million users of DSL, which it resells in partnership with telecom carriers.
But even keeping existing users won't be easy in the face of rivalry from cable and telecom carriers offering a broader range of services. Earthlink offers a bundle of broadband access, Web calling, and satellite TV for $94.94 a month—though only in Chicago, Dallas, Los Angeles, San Diego, and San Francisco. Verizon and AT&T offer a comparable package, with wireless as an option as well, across large swaths of the country. Even cable providers are introducing their own versions of mobile-phone calling, increasingly integrated with other services, such as home TV. While Earthlink offers Helio, the service is not integrated with other products.
Smaller Ambitions
Earthlink's plight will only worsen as broadband growth decelerates. Broadband adoption will only grow 10% annually through 2011, vs. 20% previously, Forrester says. "The competition is just fierce," says Michael Cai, an analyst with consultancy Parks Associates. "It's really difficult for Earthlink to compete in this market environment."
While Earthlink could have revved up its business through marketing and an investment into integration of its various offerings and new video services, the company may lack funds to do that. "They have the right building blocks," says Forrester's Cohen. "The problem is, they don't do the right messaging." Already, a lack of aggressive marketing is keeping Earthlink from generating fast growth from its Web-calling division, analysts say.
If Earthlink wants to go it alone, it may have little choice but to remain a small regional player, generating little growth and even possibly losing users, but producing a steady stream of cash. It's not an attractive scenario to many investors, but it may be one of the few options left to Earthlink. "There are many perfectly respectable businesses—small rural telcos—like that," says Andrei Jezierski, a partner at New York venture consultancy i2 Partners. "[With their growth plans], they've come to the end of the runway."
Kharif is a reporter for BusinessWeek.com in Portland, Ore.
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