EarthLink Is Still Looking for Consolidation in Dial-Up

Shares of EarthLink Inc. (ELNK) were down 3% in early trading on Wednesday after rallying 10% on Tuesday following release of the Internet service provider's second quarter earnings. Speculation continues on whether EarthLink will acquire the dial-up business of rival AOL LLC, particularly after comments the company made during its conference call on Tuesday and a Wall Street Journal interview with company CEO Rolla Huff.

Huff told the newspaper that a merger of the two businesses would create cost savings and better service, which would benefit both customers and shareholders of both companies and that it was something he thinks is "worth aggressively pursuing."

While the tone of the comments is strong, a story suggesting EarthLink is pursuing AOL's dial-up business is nothing new and has been speculated for at least a few quarters. AOL parent Time-Warner Inc. (TWX) in February said it would be splitting off the access business from its Web site and online advertising operations, fueling belief it could eventually sell the asset.

While investors may be concerned that EarthLink could wind up paying too much for AOL's assets, particularly with the dial-up access business in decline as users switch to broadband, an acquisition is mostly seen in a positive light. In a research note put out after EarthLink's earnings, Jefferies & Co. analyst Youssef Squali reiterated a buy rating on the stock in part due to anticipated consolidation of dial-up access, likely through acquisition of AOL's access business. He writes that such an acquisition "could prove highly lucrative" because of anticipated cost cuts EarthLink could make if it acquired the business.

But others aren't so sure a deal is imminent. Cowen and Company LLC analyst Jim Friedland speculates in a research note Wednesday that based on management comments Tuesday, he no longer believes an acquisition AOL's dial-up business or Microsoft Corp.'s (MSFT) MSN dial-up business is likely.

While Huff did say on Tuesday that EarthLink is well-positioned to be a faciliator of consolidation in the sector, he added that it may not be in the company's interest to wait "indefinitely," appearing to signal it wouldn't make a deal with AOL unless it was on favorable terms. He said if there are no alternatives that can provide scale, operating synergy and an acceptable risk-adjusted return, it would instead return the company's cash to shareholders through a stock buyback and/or dividends. He said he expected more clarity on its plans by the end of the year.