The Best and Worst
Stocks of 1997
Winner -- MindSpring Enterprises
The Company's Biz. MindSpring Enterprises provides people with Internet service. It's really that simple. In business since 1994, Atlanta-based MindSpring offers four different pricing plans -- including one for unlimited monthly access -- with all the features one expects from an Internet service provider (ISP): email, FTP, chat capabilities, and World Wide Web access. MindSpring also provides servers to host websites for companies and individuals that do not have their own. In the last two years it has expanded its corporate business.
MindSpring began as a regional service, but quickly expanded nationally. It now has almost 200,000 subscribers in 200 cities. (America Online, by contrast, has more than 10 million subscribers.) Users tend to point to MindSpring's simple installation and its ease and reliability of access to the Web as reasons for its growing popularity. MindSpring's business plan, though, has depended on something other than word of mouth. Its major growth over the past two years has come through acquisitions. The company bought accounts from twenty tiny ISPs in 1994 and 1995, purchased 100,000 accounts from PSINet in 1996, and added accounts from 13 more ISPs in 1997.
The Story. MindSpring's story is that of a company that has remained dedicated to the consumer Internet business even as most of the other players in the field have abandoned it. Aside from IDT, in fact, there are no other publicly traded ISPs out there that derive most of their revenues from access fees. Despite this, and despite the perpetual turmoil in the industry, MindSpring has reaped the rewards of steadily increasing revenues and steadily decreasing losses. The company saw revenues rise 700% in 1996, and is now enjoying year-over-year sales growth of close to 250%. At the same time, MindSpring has seen its losses shrink from $0.53 a share in the third quarter of 1996 to $0.08 a share in the third quarter of 1997, and analysts now estimate that the company could actually report positive earnings at some point in 1998.
MindSpring has also benefited from the ever-present possibility of being acquired by a local phone service provider, a possibility that became stronger in many investors' minds when this year saw Intermedia Communications buy Digex and GTE pick up BBN. The granddaddy of all these acquisitions, of course, was MFS Communications' 1996 purchase of UUNet Technologies for $2 billion at a time when UUNet's revenue run-rate -- its last reported quarter multiplied by four -- was $172 million in sales.
Merging with a phone company seems to make sense from both ends of the spectrum. ISPs, particularly ones that do most of their business with consumers, watch a remarkable percentage of their revenues walk out the door in the form of payments to their local phone companies. ISPs are charged for the business lines they use to connect their modems to the phone numbers that customers dial to gain access to the Web. The cost of building a network is the single largest expense that these companies have, and a merger with a phone company would eliminate all those access-charge hits to the bottom line.
From the other side, assuming that Internet service is a business that's worth being in -- and considering that just 12% of all Americans are hooked up to the Net, it might very well be -- local phone companies can benefit from ISP expertise in hosting websites and providing other value-added services to customers, particularly corporate customers. As yet, though, there's no evidence that MindSpring has seriously contemplated any takeover offers, and its heavy focus on the consumer business might make it a less attractive candidate.
How Could You Have Found This Winner. The UUNet acquisition meant that ISPs would trade at higher valuations than they would have on their own merits. In addition, the performance of stocks like Yahoo! and America Online suggested that investors remained infatuated with the Internet (though the fundamentals of AOL's business are so different from those of MindSpring as to be useless for the purposes of comparison). More importantly, MindSpring's rapid quarter-over-quarter revenue growth and its decreasing losses have been impressive. ISPs need to be valued on a price-to-revenue-run-rate basis, since most of them remain in the red because of the costs of building out the network. Even as late as this summer MindSpring's valuation was low compared to that of many of its peers, though not as attractive as either NetCom or BBN.
The Future. The real problem for MindSpring is that the economics of the consumer-driven ISP business are not good. Even with a growing customer base, it is far from clear that $19.95 a month is enough to keep the company growing and its network expanding. Internet access per se is a low-margin business. Higher-margin revenues come from advertising and Web-based transactions, but MindSpring has access to neither of these. As NetCom's decision to abandon consumer Internet access suggests, the real future in this business is with corporate customers and with website hosting. MindSpring has made tentative forays into both of these areas, but the core of its business remains consumers, which does not bode well for the company's ability to grow rapidly in the future.
-Jim Surowiecki (TMF Cinder)
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