A World Beyond Dial-Up
LOS ANGELES — Garry Betty, the chief executive of EarthLink, has an expression he uses to talk about companies that, despite obvious flaws, enjoyed success during the Internet bubble: “Even turkeys can fly in high wind.”
The question is whether that maxim might now apply to his own company: do EarthLink’s investors have a turkey on their hands?
EarthLink’s core business is dial-up Internet access, and it soared during the dot-com boom, becoming a widely known brand and the second-largest Internet on-ramp after America Online. But that business is threatened with obsolescence in the era of broadband, and without a network of its own, EarthLink has had trouble competing with the cable and phone companies in selling high-speed access.
Although the dial-up business still generates a mountain of cash, that is likely to dwindle. So EarthLink, which is based in Atlanta, is pouring money into new ventures as it tries to turn itself into a full-service telecommunications company.
That kind of transformation would be hard for any company to pull off. Much attention has been paid lately to the makeover efforts of AOL, which is choosing a different route and moving to a media-style business model that, in the spirit of Google, relies on free or low-cost services with targeted advertising. It is not yet clear that the strategy will succeed.
Dial-up companies “can either go down the telco path or go down the media path, and both are extremely challenging,” said James H. Friedland, an analyst with Cowen & Company, who has a sell rating on EarthLink’s stock. Mr. Friedland says he believes there is no middle ground for EarthLink — either the company’s new investments will fail, leaving it in deep trouble, or they will succeed. “And if it succeeds, it could be a home run,” Mr. Friedland said. “If they’re successful, the stock is cheap.”
Mr. Betty counters that the new path is less dangerous than it may seem, in part because EarthLink’s dial-up business will not die overnight.
“My track record, the company’s track record, should be a harbinger,” Mr. Betty said. “We have 10 years of history. That should be worth something.”
He adds, though, that “no one that started in dial-up has made any transition like this.”
EarthLink has introduced three new efforts: it is offering packages of phone service and fast broadband, building citywide wireless networks in places like Philadelphia and San Francisco, and, most daring of all, embarking on a $450 million joint venture with SK Telecom called Helio, a mobile phone service aimed at well-off young adults.
Mr. Betty said that the new ventures were natural outgrowths of its business, and that it would take only a small slice of a new market to give a lift to EarthLink’s $1.3 billion in annual sales. Helio, which he called the riskiest of the three efforts, has predicted that it will have $2 billion in revenue and three million subscribers by 2009.
Shares of EarthLink, which peaked at a split-adjusted $62.47 in 1999, plummeted along with the rest of the industry when the boom went bust. They closed at $7.56 on Thursday, near their 52-week low of $7.03.
In an interview in the Los Angeles headquarters of Helio, Mr. Betty, 49, conceded that the transition would inflict short-term pain on EarthLink’s balance sheet. Last month, the company announced second-quarter earnings of $16.6 million, down from $43.8 million a year ago.
In a conference call with analysts, the company said that for the full year it expected to have profits of zero to $20 million, down from $143 million a year earlier.
But Mr. Betty, a regular dispenser of homegrown homilies and frank analysis, has seen challenging times before at EarthLink. When he came to the company in 1995, it had 200 employees chaotically carrying out the vision of Sky Dayton, then 24, who founded it as an alternative to the major dial-up players.
At the time, EarthLink was adding subscribers hand over fist, growing 10 to 15 percent a week, but it was also losing money just as quickly. “We were functionally bankrupt for all of 1996,” Mr. Betty said. “I think only I and the C.F.O. really knew.”
The company borrowed money on the promise of its speedy growth and went public in the first quarter of 1997, along with Amazon.
The company built a reputation for customer service and as a consumer-friendly alternative to America Online and the smaller Prodigy and CompuServe. Back then, dial-up Internet access was the only game in town, and EarthLink blossomed, growing to $1.2 billion in revenue in 2000.
But that was about the time broadband began to go mainstream, as the cable companies pushed high-speed service, with the Bell companies soon to follow with D.S.L.
As those technologies have added customers, EarthLink’s brand has faded. At one time, the name was recognized by 95 percent of consumers, but that number has slid to around 65 percent, Mr. Betty said.
The company still has some things going for it, notably how much cash it generates: around $36 million each quarter. That is a function of the high profit margins of the dial-up business; not including sales and marketing costs, the company earns $12.50 for each subscriber to its $21.95 monthly premium dial-up plan, which includes spam and pop-up blockers and free customer service. EarthLink also offers stripped-down service under the PeoplePC name for $10.95 a month, and $6.50 of that is profit.
“They have a great brand, great customer service, and they’ve done a great job managing expenses,” said Timothy Horan, a telecommunications industry analyst with CIBC World Markets. Mr. Horan has a sell rating on the stock because he is not certain EarthLink can fulfill its vision for growth.
The dial-up customers are not going away so much as shifting from the premium service to PeoplePC and to EarthLink’s own broadband service, which it offers by leasing lines from cable and phone companies. In its second quarter, it said it lost 163,000 premium dial-up customers, but added 48,000 PeoplePC customers and 116,000 broadband subscribers.
Over all, EarthLink has 3.5 million dial-up subscribers and 1.8 million on broadband, where growth has been slow because EarthLink has not been able to reach deals with some cable companies.
Mr. Betty said the dial-up business would not disappear too quickly because there were still considerable pockets around the country unable to get broadband. But he said the company was not content to just ride out the dial-up wave. “As people in the tech business, that’s not our aspiration,” he said.
Perhaps the most visible part of EarthLink’s new strategy so far has been its effort to build citywide wireless networks. It is operating such a network in Anaheim, Calif., and building one in Philadelphia. It has contracts to build in several other cities, including New Orleans, and is working on a final agreement in San Francisco, where it plans to work with Google.
The idea behind the networks is to provide a wireless alternative to broadband for city residents and give tourists and business travelers a place to log on for the day. The projects are expensive: $85,000 a square mile, or $10 million to $15 million to cover all of Philadelphia, for example. Mike Gallentine, vice president of investor relations for EarthLink, said the business took advantage of expertise the company already had: “In terms of the skill set we need, it’s the same as what we’re already doing, which is Internet access.”
But analysts counter that building and operating a Wi-Fi network presents considerable new challenges for EarthLink, and returns are uncertain. “It’s got possibilities for them, but it’s a start-up, a full start-up,” Mr. Friedland said of the concept.
The second major part of EarthLink’s plan is Helio, a joint venture with SK Telecom, South Korea’s largest telecommunications provider. Each company has invested around $225 million in cash and assets into Helio, which opened its doors in May, offering two slick phones aimed at 18- to 32-year-olds. Helio is putting an emphasis on data services like text messaging that are popular with young people, including an exclusive deal that provides easy mobile access to the social networking site Myspace.com.
In the mobile phone market, “the U.S. is dominated by large generalists,” said Mr. Dayton, who is now Helio’s chief executive and is no longer involved in running EarthLink, but remains its largest shareholder. The service is aimed at “young, passionate consumers who like high-end devices,” he said.
And who, apparently, have relatively deep pockets. Until this month, the lowest cost of service from Helio was $85 for unlimited data and 1,000 minutes of talk time; unlimited calling and data costs $130 a month. The company recently added a $65 plan. Its phones cost more than $200.
Asked whether young people could afford such expensive service, Mr. Betty said the company was aiming at a generation it calls “feed me, see me, spoil me,” who have some cash to burn. “How many kids drive around with BMW’s?” he said. “They have the money.”
But Helio is not the first carrier chasing a niche market, and some others have struggled to find a large enough audience to justify the investment, industry analysts said.
Mr. Dayton declined to give subscriber figures, but he said Helio was on track to meet its goals.
EarthLink has gotten into the voice business on a second front with two new products. One is an Internet-based telephone service like Vonage that costs $24.95 for unlimited calling and has around 13,000 subscribers.
The second product is more unusual. It combines extremely fast broadband Internet access (up to 8 megabits a second, more than four times as fast as most services) with traditional phone service, delivered over lines leased from local phone companies by its partner Covad. The price for the package, with unlimited calling, is $70, a cost EarthLink believes will allow it to undercut and beat cable and telephone companies at their own game.
The company now offers the package in four cities: Seattle, San Jose, Calif., Dallas and San Francisco, where it opened a storefront last month to promote its new services.
On a recent afternoon, the sales staff at the San Francisco store succeeded in signing up a new convert, Linda Hegenbarth, a legal secretary. She had used AT&T for phone service but had been looking to switch after reading that AT&T had turned over phone records to the National Security Agency.
Her choice seemed to be more of a rejection of another company than a pure embrace of EarthLink. But, from Mr. Dayton’s perspective, that’s not such a bad thing.
“We’ve always been about being an alternative,” he said.