AOL, Microsoft Cast Long Shadows, but Independent
ISPs Find Place in Sun
Friday August 06, 1999 (5:04 pm ET)
personalwealth.com
By Mark Cavallone, S&P Telecom Equipment/Internet Analyst
NEW YORK, Aug. 06 (Standard & Poor's) - With 17 million
subscribers, America Online (AOL) is a hulking presence
in the world of Internet service providers (ISPs) and is many times larger than its nearest competitor. AOL's size, of course, has its advantages. The ISP business is essentially a scale business -- the more customers you have the higher your level of profitability. Running a network involves lots of fixed costs and when these costs are spread over a large subscriber base, large amounts of profits ensue. But size also has its disadvantages. For example, AOL no longer escapes the notice of companies such as Microsoft, which is now apparently taking aim at AOL's leadership position. In fact, the impending competition with Microsoft was one of the reasons I recently downgraded AOL to an accumulate from a buy.
Even with AOL's strong presence, I believe there's room for multiple ISPs to flourish. The increasing amount of time people spend online and the proliferation of low-priced PCs used primarily for Internet access ensure a steady flow of potential customers. In fact, thousands of independent ISPs
exist today. Two of the largest are Earthlink Network (ELNK) and MindSpring Enterprises (MSPG).
The companies have traveled different paths in building their subscriber bases - MindSpring through acquisition and EarthLink through marketing expertise. Both strategies have been successful so far. But I think that's about to change, which is why I have EarthLink ranked as (buy) and MindSpring (avoid).
MindSpring, with 1.2 million customers, up from 287,000 at
the end of 1997, has focused on buying smaller ISPs. MindSpring's two most prominent acquisitions, which have
added over 500,000 subscribers, are Sprynet, a former
subsidiary of AOL, and Netcom, which used to belong to
ICG Communications. The company's Internet service is
available in most parts of the country, and I see sales of
$338 million in 1999 rising to $477 million in 2000.
Acquiring subscribers has served MSPG well in past
years, but even with the recent weakness in Internet stocks,
I think it will become increasingly difficult for MSPG to find appropriately valued smaller ISPs to purchase. The
company now needs to change its focus and grow subscribers through marketing means. During their second-quarter
conference call, the company formally announced just such a plan, which involves heavy spending over the near-term. The news negatively affected, MindSpring's stock, and the company's share price has continued to fall along with the majority of other Internet stocks'.
EarthLink, although it did acquire about 130,000 subscribers from Sprint in 1998, has grown primarily through its own marketing abilities, including an advertising campaign, mass mailings and distribution deals with PC manufacturers such as Apple. ELNK, founded in California, now has a nationwide presence and as of the end of the second quarter, has 1.32
million customers, up from 420,000 at the end of 1997. I see sales of $325 million in 1999 rising to $540 million in 2000.
Unlike MindSpring, EarthLink has had many years of experience in marketing its service. The company also has an agreement with Sprint (27% owner of ELNK), which helps market ELNK's service. Sprint guarantees it will add an average of 150,000 subscribers a year to EarthLink's total membership over the next four years. It is precisely these
types of agreements that MindSpring needs to make in order to succeed in the increasingly competitive ISP industry. While it is possible for MSPG to grow itself through similar methods, I'll remain skeptical until I begin seeing evidence that their new marketing plans are having an impact.
A company such as EarthLink, which offers high-quality service, should be able to prosper underneath the radar screen of giants like AOL and Microsoft. I currently expect subscribers to grow to 1.8 million by the end of this year and to 2.7 million by year-end 2000. After incurring losses through much of this year, I see earnings of $0.75 a share next year, as rising sales and improving gross margins help to offset the high levels of sales and marketing expenses. With about $10 a share in cash, I believe the shares are an exceptional bargain, trading at about 2x my 2000 sales estimate.
06-Aug-1999 17:04:46 (02167771) Copyright 1999 Standard & Poor's Investment Advisory Services LLC. The information contained in this report may not be published, broadcast, rewritten or otherwise distributed without prior written consent from Standard & Poor's. |
