Earthlink: In All The Right Places? (ELNK)

| About: EarthLink, Inc. (ELNK)
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Earthlink was an early national ISP, providing service mostly through dialup, but also DSL. I used them for many years, and had quite problematic service from them. They had a bit of a strange place in the market - they provide a service overlaid on the backbone owned by others (in this case the baby bells). Their infrastructure providers also turned out to be their competitors, and because of this attributing the quality of service problems was difficult (both sides blamed the other).

Earthlink did not have complete control over their service, and the baby bells purposefully deteriorated their service in an attempt to get users to switch to their own competing service (they would tell me things like '...your line isn't provisioned for DSL because of blah blah blah, so Earthlink can't provide you the service, but we could...' when if their provisioning claim was true then they couldn't, and Earthlink was in fact providing service, showing that the provisioning claim was false. In a word, they were a bunch of liars.) As a result of those manipulations, neither of those companies have had me as a customer for many years now.

I bring this anecdote up because, on the one hand, Earthlink is firing on all cylinders with some interesting product offerings. On the other hand, for most of those offerings they are resellers, and/or agreement based, rather than owned by Earthlink. That leaves the possibility that their quality of service could once again be out of their own control. Perhaps they learned something from the past, and perhaps their new partners are true partners rather than back-stabbers, but there is certainly a risk there.

Now, on to their actual service offerings, which are each somewhat unique:

* MuniFi - many municipalities nationwide have taken it upon themselves to build out an urban WiFi network, with the contracts bid out to providers. San Francisco, for example, will offer a two tier service with free, slow, advertiser supported service provided by Google, and a somewhat faster, paid service provided by Earthlink.
* SK Telecom Wireless - They are forming an MVNO (a mobile virtual network operator) with SK Telecom. We've discussed that aspect already.
* Covad VoIP - They are rolling out a line-powered VoIP service provided by Covad, that differs somewhat from other services in that no equipment is necessary on the user' premises, and the service stays active even if power goes out to the customer. It's a good add-on for their DSL service, but I don't find their pricing compelling, and it is unclear to me whether their service is a true replacement for Bell provided POTS phone service (Earthlink does not own the phone lines going to the home). DSL service still has severe range limits, with the higher speeds only available to a small fraction of the serviceable households, unlike cable or FTTH.

So, they are positioning themselves somewhat uniquely in the marketplace. Each of those services has special features that distinguish them, but they each also operate in a competitive milieu. Pricing is important, and on that front the services are not yet overly attractive. Whether the marketplace calls them a winner or not remains to be seen.

Company: They just released Q1 2006 numbers. Operating earnings are about flat Y/Y for 2005 at $214M, out of $1.3B operating revenue, for an OP margin of 16.6%. For 2006 they expect to be somewhere between flat and a $45M loss. They give a lot of information in their recent presentation, but most of it is Story. What it comes down to is that their traditional dial-up business is about to be dead, and they are transitioning to a completely new company. So far, they are managing that transition well (they have operating profits). Whether the new offerings rake in the profits or turn out to be big advertising and operations sink holes is just plain unknown at this time. So, we think of them as a turnaround with a possibly Spectacular Story.

Stock: ELNK has been around a long time. The play here is really based on Story, since the numbers are not firm enough to tell us anything. 2006 is, in management's words and in our opinion, a transitional year for them. I find their story interesting, but that is a long distance form actually profitably operating all the new programs. Fiber-to-the-home and VoIP will come on strong in 2006 and forward, WiMax will come on in 2007 or later, WiFi and Cell Phones are merging, etc. It's a sector in upheaval, which is good if you are on the right side. ELNK may be worth a bet, but that is what it would be.

ELNK 1-yr chart:

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