Novice Investing - Hooking Up With Earthlink

Date: Monday 01st 2008f December 2008 05:13:11 PM

Hooking Up With Earthlink - 06/05/2006

By: Novice Investing Staff

Late last year, before Google announced a $ 1 Billion stake in American Online (AOL), we raise a possibility for companies to snap up a much smaller rival, Earthlink Inc. (ELNK). On December 2005, Google reveal a 5% stake in AOL amounting to $ 1 Billion. Gasp. AOL, with 20 million dial-up subscribers and declining, is valued at $ 20 Billion.

Now, of course, Google was not valuing AOL based on its 20 million dial-up customers. It was more interested in obtaining AOL's rich content away from its competitors, mainly Microsoft Corp. (MSFT) and Yahoo! Inc. (YHOO). While Google is moving towards content these days, the one differentiating factor is search. Google derives 99% of its revenue from online advertising derived by search. Therefore, AOL content is not as important as keeping it away from competitors.

All right, Google does not value AOL based on its declining dial-up customers. But, potential Earthlink acquirer must! While Earthlink plays second fiddle to AOL, we must say that it has quite an attractive valuation these days. With $ 320 Million in positive net cash, acquirers need to come up with a mere $ 820 Million these days. If you add in its $ 177 Million of its long-term investment, Earthlink looks much much cheaper. Let's ignore this portion for a moment. At this point, earning tops $ 143 Million last fiscal year. This is about six times earnings. Can it get better? Perhaps.

Unlike its much bigger competitors, AOL, Earthlink seems to be making progress of gaining broadband customers. There is no question that dial-up subscribers are declining. Fortunately, Earthlink has quite a loyal followings. About one third of its broadband customers came from its existing dial-up subscribers. The good thing is that Earthlink never owns those expensive network from the beginning. It always rent spare capacity from other telecom companies. This makes capital expenditure lighter.

Now, the company is embarking on different strategies. It is planning to own its own networks. It has won several bids to provide Wi-Fi Access to two cities, namely Philadelphia and San Francisco. The latter is in

partnership with Google. This will put Earthlink one step ahead of its larger rivals. For one, building a Wi-Fi network costs a mere $ 100,000 per square mile. About $ 5 million is required to cover the city of San Francisco. In addition, Earthlink contends that it can cut the network cost in half once it negotiates larger order with suppliers.

Let's do a simple calculation here. With about $ 300 Million in the bank, Earthlink can own its own network in 80 big cities. (Not all cities are of the size of San Francisco). Assuming a population of 300,000 households each, which is a conservative number, Earthlink can get access to 24 Million households. If it can get around 6 Million households and make them pay $ 20 per month for Wi-Fi access, that is about $ 120 Million in revenue per month or $ 1.4 Billion annually. The question here is can Earthlink build this network within the next five years? If so, then current price will be quite a bargain. You see, when you own your network, you can still lease your spare capacity to competitors at a lower price. That is yet to be accounted for in our revenue estimation figure.

With its own network access, profit margin will be higher while in this case, investment cost is not terribly big, unlike billions of dollars spent on delivering internet connection via cable TV network, for example. Investors, however, better hope that current dial-up defection are not that steep. Earthlink still needs the cashflow to fund its Wi-Fi projects. The threat of telecom companies building up its own Wi Fi Network seems remote. Even if they did try to build their own Wi Fi Network, most big telecom companies are reluctant to engage in price war since they still try to recover those billions of dollars invested in copper line or cable TV.

So, Earthlink is definitely worth looking at. We are not surprised if it is snapped up by bigger companies wanting to convert Earthlink's subscribers into their own. If it is not acquired, the prospect of Earthlink's Wi Fi project still looks bright. If all those dial-up customers defect within five years, Earthlink may still have the potential to replace 100% of those revenue with its new Wi-Fi initiatives. We will have more to say if its stock price move. Stay tuned.

END

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding Earthlink Inc. (ELNK) or any other securities.

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