Friday, January 09, 1998<Picture>Erol's Chooses Close-To-Vest Financing
By Randy Whitestone
January 6, 1998 12:15pm
Inter@ctive Week
Net Income
I can't get the Erol's Internet Inc. commercial out of my head. If you don't live in the Northeast Corridor, you may not have heard its thumping, wordless, insistent beat, capped off by the telltale tone of a modem connecting. If you do live in the greater BosWash metropolis, Erol's is a name you probably know.
That's handy for a company attempting an initial public offering (IPO), which Springfield, Va.-based Erol's -- led by the aggressively flexible Onaran family -- hopes to do by early 1998.
Buying name recognition is costly, as Erol's neighbor Steve Case or any other politician can tell you. In the first nine months of 1997, Erol's spent $15.5 million on sales and marketing and attracted 128,040 new customers. That's an acquisition cost of $121 per customer -- about the same as EarthLink Network Inc.'s figure of $116 for the same period.
Erol's (www.erols.com) has four price plans ranging from $19.95 per month for month-to-month access to $10.95 per month for a three-year plan. Assuming three-fourths of users take the $10.95-per-month option and one-fourth pays $19.95, the companywide weighted average is $13.19 per month, so payback is nine months. The company claims a subscriber churn rate of only 2 percent.
The profit equation is impressive, since Erol's claims each dollar of service revenue costs only 44 cents to provide. Compare that with equipment-centric Concentric Network Corp., at $1.43, or access reseller EarthLink, at 53 cents.
But Erol's has taken a risky path, scurrying forward beneath a vast liability hovering above its balance sheet like a lumbering zeppelin. Erol's has a short-term liability of $23.7 million related to its prepaid subscription plans for subscribers who could cancel in the next 90 days.
The liability is three-fifths of Erol's working capital deficit of $38.7 million. Even after the IPO, the company would have a working capital shortfall of $11.4 million, according to its filing. Its accounts payable and other accrued expenses totaled $15.7 million at Sept. 30, vs. cash of only $533,000.
Is this an Internet service provider (ISP) or an apparel company? In New York's Garment District, short-term liabilities are accepted business practice, and factors make short-term loans against merchandise in transit.
So who is Erol's factor?
There's no simple answer. Erol's has cobbled together funds from founders, customers, suppliers and an offshore corporation to pay its bills.
Erol's biggest creditor is Ascend Communications Inc. (www.ascend.com), provider of servers and modems that comprise 72 percent of Erol's network hardware costs. In its filing, Erol's said it is working to reduce unspecified payables to Ascend by $4 million, borrowing $500,000 at 10 percent, and receiving unspecified infusions from vice chairman and majority shareholder Erol Onaran to cover working capital through October 1998. Onaran has also personally guaranteed Erol's lease with Ascend as well as leases with General Electric Capital Computer Leasing Corp. and MicroTech Leasing Corp. and the bank loan. Onaran, for those unfamiliar, built a Washington, D.C.-area home-electronics empire from a single store, then started a video rental business he sold to Blockbuster Entertainment Inc. in 1991 for $30 million. Erol's Internet, started in 1995, is a third act.
One other sugar daddy is a finance company called Gold & Appel Transfer S.A., based in beach-dreamy Tortola in the British Virgin Islands. In three transactions in nine months, Gold & Appel has acquired a 31 percent stake in Erol's by paying $4 million to the company and $1 million to Onaran. Gold & Appel is described as a wholly owned subsidiary of Iceberg Transport S.A., a Panamanian company. Not your average Sand Hill Road venture backer.
Then again, Erol's -- and Erol -- have always taken an interesting, if indirect, path from obscurity to fame.
Randy Whitestone is Business & Financial Editor of Inter@ctive Week. Reach him at rwhitest@zd.com on the Internet.Erol Onaran built a home-electronics empire from a single store, then started a video rental business he sold to Blockbuster |
