EarthLink, An Interesting but Risky Investment (ELNK)

It's time for another stock evaluation. Today, the company is the ISP, EarthLink (ELNK).

Step 1: FCF/EV yield vs. Treasury yield

Price per share = $8.41

Enterprise Value (EV) = $845M

Free Cash Flow (FCF) (Normalised) = $94M

FCF/EV yield = 11.1%

Treasury yield (30 years) = 5.03%

EarthLink looks like a better deal when compared with the treasury yield.

Step 2: Insider holdings

Founder Sky Dayton and insiders have holdings of over 10% of the EarthLink.

Step 3: Is EarthLink a good Company?

Profit Margin: 9.94%
Operating Margin: 11.77%

Return on Assets: 10.41%
Return on Equity: 23.63%

EarthLink has both a good Return on Assets and Return on Equity.

Step 4: Is EarthLink management shareholders-orientated?

EarthLink has been buying its own shares aggressively: $85.8M (2003), $108M (2004) and $169M (2005) over the last three years respectively.

Step 5: Do you understand its Business?

EarthLink provides Internet access and related services to individual and business customers in the United States. Its primary service offerings include narrowband Internet access, including dial-up access over traditional telephone lines; broadband access via DSL, cable, satellite, and dedicated circuits; advertising and other services; and Web hosting. The company also sells equipment and devices used by subscribers to access its services. It has strategic alliances with Sprint Nextel Corporation (S) and Dell, Inc. (DELL). The company provides its services to approximately five million paying customers through a network of dial-up points of presence and a broadband footprint. EarthLink was founded by Sky Dayton in 1994 and has its HQ in Atlanta, Georgia.

Step 6: Does EarthLink have a Moat?

No.

Step 7: Does any superinvestor invest in EarthLink?

No.

Step 8: What are the potential risks in buying EarthLink?

According to the Morningstar Report,

Earthlink faces intense competition from Time Warner's TWX AOL unit and Microsoft's MSFT MSN service in the market for dialup access, as well as the nation's largest cable and telephone companies offering broadband service. These competitors have considerably greater scale and financial resources.

Intense competition is resulting in heavy customer churn for Earthlink. In addition, the firm is seeing steadily decreasing average revenue per subscriber for its premium narrowband and broadband services.

Earthlink does not own its broadband network and must negotiate with its competition to gain access. This puts the firm at a disadvantage as customers rely more on price as a differentiator and increasingly seek to bundle broadband Internet access with cable TV and phone service.

Earthlink is pursuing new growth opportunities. The company recently entered into a joint venture with SK Telecom SKM, South Korea's largest wireless carrier. The business plans to offer wireless communications services and equipment to U.S. customers. However, it is still early to decide whether this is a successful venture or not.

In addition, there have been widespread reports that insiders have been selling shares of the stock since last year, always a potential sign of bad things to come.

Conclusion:

Earthlink ($8.41 per share) is an interesting stock with low valuation, which is rightly so, as its future outlook is uncertain. It doesn't have a moat, and there is no superinvestor buying this company.

On the other hand, there are still significant insider holdings and the management have been doing right in terms of share repurchase.

ELNK 1-yr chart: