Dueling Fools

Dueling Fools
@Home Alone
January 27, 1999

@Home Bear's Den
by Chris Rugaber (tmfrfk@aol.com)

This sure is an easy Dueling Fools to write! @Home's industry is fairly stable and boring, without anything unexpected or unpredictable on the horizon. The company's purchase of Web portal Excite doesn't really make much difference to its future. On the whole -- yawn -- I think I should be able to whip something up on this pretty easily.

Not! If I was @Home's CEO, Tom Jermoluk, I would already have an ulcer. On the other hand, he's probably having a lot of fun, given that his company is in the thick of the chase for the holy grail of telecommunications: broadband multimedia Internet services. @Home definitely has moved more quickly than others and has begun to establish a brand name, but it is far from "winning" this race or even coming close to establishing a sustainable, dominant position.

There are a tremendous number of factors to consider if you're looking at investing in @Home: the technological and customer service challenges, the multiple sources of competition, the regulatory environment, @Home's relationship with AT&T, its relationship with its cable partners, and its business model. All these factors could significantly affect @Home's future, and many are interrelated. The overall industry is like a Rubik's Cube: every change will cause multiple related changes.

In addition, always keep in mind that @Home's stock is priced ahead of its business. I am not going to use the word "overvalued," but to invest in @Home at $109.75 per share (its closing price on Wednesday, January 20th) is to take on huge risk and uncertainty. This is roughly twice the price the Rule Breaker portfolio paid for the stock, and the higher price amplifies the multiple risks @Home faces.

I've only got space for a quick valuation, but using Jermoluk's and Excite's CEO's guess of $2 billion in revenue with a 20% profit margin by 2002, we can very roughly estimate @Home's 2002 earnings per share (EPS) at $2.30. This means investors are currently paying almost 50 times earnings four years into a very murky future. This is a generous estimate, since @Home's share count will almost certainly be significantly diluted by then (more on this later), and let me tell you: no one has any idea of what the broadband access industry will look like in 2002. Heck, just what happens this year is wildly up in the air. And by the way, almost half that revenue is supposed to come from Excite, which is also in kind of a competitive, rapidly-changing business.

Keeping the high price of @Home shares in mind, here's what the company's faced with just in the next year or so:

Competing Technology. As Jeff probably already mentioned, @Home uses an upgraded cable infrastructure and its own intranet to deliver perhaps 1-2 megabits per second (Mbps) per customer digital throughput. The primary competition comes from Digital Subscriber Line technology, or DSL, with Asymmetric DSL being the leading variety. ADSL equipment turns normal copper phone lines into high-speed digital lines with up to 1.5 Mbps throughput. (Of course, your mileage may vary for both cable and ADSL).

ADSL's advantages over cable include the fact that it provides a dedicated line to the customer, while cable lines are shared with other customers in the neighborhood. As a result, if your neighbor is trying to download his or her favorite MTV videos while you're online, expect slower service.

In addition, ADSL runs over existing phone lines, whereas @Home (and other cable modems) require newer cable lines, known as hybrid fiber-coaxial (HFC), in order to provide two-way transmission. The recently introduced standard for ADSL modems, variously known as "g.lite" or "ADSL Lite," may not even require adjustments to a subscriber's line; in that case, ADSL providers would not even need to "roll a truck" to hook up a new customer, while @Home, like its cable company partners, needs to send a technician to your home. (This will require broader testing to be firmly established, though. And "ADSL Lite" is likely to be slower than the 1.5 Mbps I mentioned above).

The ultimate goal for high-speed access is for it to be a "plug-and-play" service similar to current dial-up access with basic analog modems. "ADSL-lite" is a lot closer to that than @Home's cable service. This means that the potential for ramping up is at least the same for the companies deploying ADSL as for @Home. After all, almost all homes have a telephone line; one estimate is that only 85% of homes have access to cable, and only 65% of those are actual subscribers. This disparity between cable and phone is much greater internationally.

Certainly, making ADSL widely available will require some infrastructure upgrades. The biggest knock against ADSL is that its signal attenuates with distance; its 1.5 Mbps maximum "downstream" speed (from the Internet to the user) isn't really available for those more than 3 miles from a telephone "central office," or switching station. Yet telephone companies have been upgrading their switching stations for years and are beginning to really focus on them now, as is discussed below.

There are other competitors, such as satellite service and land-based wireless service. They're unlikely to do much in the short run, but they're another wild card in the longer term.

Businesses That Desperately Want Competing Technology. The conventional wisdom is that the Regional Bell Operating Companies, or RBOCs, are slow and incompetent and haven't wanted to develop ADSL because it would "cannibalize" their more profitable high-speed T-1 business lines. Yet RBOCs are going to need ADSL in a big way and they have figured this out. Just as it took satellite television services to make the cable companies realize they needed to provide more than TV, the RBOCs aren't going to sit around and watch @Home eat their lunch, especially when you consider that @Home is now controlled by AT&T, its largest shareholder. AT&T, of course, purchased cable giant TCI (previously @Home's largest shareholder), in order to get the cable company's access to individual homes, which will allow them to provide their own local phone services. If AT&T can offer local phone services, long-distance calling, cable, and high-speed multimedia Internet access, all in one package, as it clearly is planning to do, then the RBOCs better follow suit or they're in trouble.

Businesses That Are Rolling Out Competing Technology. Not sure about this scenario? It's already happening. SBC Communications, the RBOC of the Southwest, announced last week that it is speeding up its deployment of ADSL and dropping the price; it aims to have ADSL service available to 8.2 million homes in California, Texas, and four other states by the end of this year, at prices as low as $49 per month, comparable to @Home's price. Bell Atlantic, another of the five RBOCs, announced a day later that it will work with AOL and up to 45 other ISPs to provide ADSL service on the East Coast. Bell Atlantic is going to quadruple its ADSL-compatible switching stations and plans to make ADSL available to about 7.5 million people by the end of 1999.

By the way, the number of homes that have the necessary cable infrastructure for @Home currently stands at about 13.2 million, of which 331,000 are actually subscribing to the service. These numbers will grow quickly, but @Home is far from a ubiquitous nationwide service and is unlikely to become one for several years. Given these facts, it won't be that hard for ADSL, which currently has only about 60,000 subscribers, to quickly catch up with @Home.

Leaving aside other competitors for reasons of space, such as fiber-optic network operator Qwest and its local partners, there's AOL. David Gardner mentioned in his @Home buy report that he was more worried about AOL than the RBOCs. I think he should worry about both, but I'll leave AOL for my rebuttal, since I bet Jeff will mention it in his Bull's Pen.

Multiple Other Wild Cards. I'm already way over my allowed space, and I haven't even had time to get into @Home's customer service problems and the many other wildcards it faces, such as its future with AT&T and its cable partners. I'll address those in my rebuttal as well.

Of course, having said all this, I won't pretend to know the future of this industry anymore than anyone else. @Home may end up in good shape, and as David Gardner wrote in a recent Rule Breaker column, @Home and ADSL could both end up as viable high-speed access solutions. But if you are actually considering investing in @Home, rather than just enjoying the development of this industry from the sidelines, then do it with both eyes wide open, wait for some of the volatility to pass, and let a clearer picture of this industry emerge over the next six months to a year. You might save yourself some stress -- and some money -- by doing so.