EarthLink Still Earthbound

It's not news that EarthLink (Nasdaq: ELNK) is in the midst of transformation to an all-around communications company from a dial-up ISP, but that transformation has more than its share of challenges. Maybe investors should wonder whether EarthLink's got too many distractions as it tries to complete its metamorphosis.

Analysts may have expected EarthLink to report a profit of a penny per share, but the company reported a $0.02 per-share loss instead. Sales increased 4.5% to $331 million, which was also short of analysts' expectations. If you consult our Fool by Numbers on EarthLink, you'll also see that margins fell across the board.

EarthLink experienced a 55% decline in free cash flow to $20.2 million for the quarter. Indeed, the company continues to plow money into its transformation and growth initiatives into broadband, mobile, and voice applications -- and its cash reserve continues to dwindle (down 61% to $158.2 million on a year-over-year basis). These strategies are nothing new, of course -- check last quarter's results.

On the bright side, EarthLink said broadband revenues increased 36.7% to $149.4 million, with a 20% increase in broadband subscribers to 1.9 million. Narrowband defections continued -- as expected -- with sales down 16.3% to $150.8 million and subscribers down 8.8% to 3.3 million (although its bargain dial-up service, PeoplePC, helped offset some of those losses).

There are many people who seem to think that EarthLink is a bargain now, but I have my doubts. True, a P/E of 10 is low for a tech stock, but EarthLink has its work cut out for it, as dial-up subscribers dwindle and it has to duke it out against tons of broadband competitors -- not the least of which are cable giants like Comcast (Nasdaq: CMCSA) and telecom contenders like Verizon (NYSE: VZ), which can easily bundle services to their customers.

Meanwhile, like Time Warner's (NYSE: TWX) AOL, EarthLink has a legacy as a dial-up provider. For all that AOL has struggled to recreate itself, it saw the writing on the wall for its access business. EarthLink had very little choice than to try to alter its access business and shell out lots of cash to do it. However, when considering its municipal Wi-Fi business (which sounds like, in some cities, has glitches that management said in the conference call were a combination of operational problems and "muni politics"), or its wireless Helio joint venture with SK Telecom (NYSE: SKM), I can't help but wonder if EarthLink's got too many irons in the fire at this point.

True, EarthLink has been able to use cash from its access business to help it pay for capital expenditures associated with these new initiatives. Although it doesn't have any debt, this is all a drag on profitability, and its PEG ratio of 1.5 certainly doesn't imply it's a value at this point.

The protracted period of angst for EarthLink is reflected in its stock chart. Although there was never any question that EarthLink had to transform its business, the jury's still out on how successful its array of new initiatives will be in such a competitive environment, and I'd say EarthLink is still a mighty speculative stock for investors these days.

For more on EarthLink, dig up these articles from the Foolish archive:

• EarthLink was cut short, according to our Fool by Numbers.
• Last quarter left some wondering if EarthLink can get it together.
• Revisit EarthLink's quarterly results from last April.

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Alyce Lomax does not own shares of any of the companies mentioned.