By Jeff Fischer (TMF Jeff)
June 1, 2000

Article Synopsis: AOL investors should keep an eye on EarthLink, and especially on EarthLink's broadband business. Investors who own AOL and understand and believe in the Internet Service Provider industry may want to consider investing in EarthLink, the number-two company, too.

Foolish investors spend a good amount of time researching their companies before they make investments. Next, they conduct ongoing research after they invest in order to stay current. After all, some investors have more money invested in a company or two than they have invested in their home or their education. However, they often forget to study competitors closely, too. Only by studying competitors can you learn more about what your companies are up against.

In the initial Motley Fool Research Company Report on America Online (NYSE: AOL), we note that AOL's largest competitor by subscriber numbers is EarthLink, Inc. (Nasdaq: ELNK). Today we take an updated, closer look at this competitor to AOL to see how the company is battling for, and in various cases winning, America Online's potential customers.

EarthLink has the goal of being the highest-quality ISP with the best customer service in the country. As of March 31, its service had 3.46 million subscribers, up 54% from last year and 11% from the December quarter. Of these customers, approximately 50,000 were broadband subscribers using EarthLink's DSL (Digital Subscriber Line) or cable modem service. In comparison, America Online had 22.2 million customers in North America after adding 1.2 million in the same quarter, but AOL did not have enough broadband customers to merit a mention.

Although it is too late for EarthLink to catch AOL in the narrowband Internet service market (approximately 50% of new Internet users sign-on with AOL), EarthLink is making a meaningful sprint in the high-speed broadband market. EarthLink's broadband services cover 21 major metropolitan areas and are expected to reach 40 areas by the end of this quarter. Although America Online has a larger "footprint" (or more nationwide services) in broadband access, the company has been slow to push its service to customers.

EarthLink's most aggressive broadband initiative was announced on April 27. The company will waive all set-up fees for high-speed DSL customers -- typically $200 to $300. EarthLink will cover these costs for any subscriber, so all you need is $49 a month and EarthLink will provide your home with DSL Internet access. EarthLink's biggest investor is Sprint PCS (NYSE: FON) and its largest DSL partner is COVAD. New partnerships with regional Bell companies, increased marketing and promotion, word-of-mouth, and "self-install" DSL kits all stand to drive more DSL users to EarthLink this year.

This is important because high-speed access is expected to be a bigger long-term breadwinner for ISPs than narrowband access. Broadband users spend more money per month for access, they spend more money online, and they spend more time online, resulting in higher advertising and commerce revenue for the provider. Broadband users also expect higher quality service, which is one of EarthLink's large selling points: "We focus on great customer service. Can our largest competitor -- AOL -- do the same?"

Revenue at EarthLink in the first quarter was $219.7 million, up 69.7%. Over the same period, AOL had revenue of $1.8 billion, up 47%. For the year, EarthLink is on track to have 4.5 million subscribers (over 150,000 of them being broadband users) and $1 billion in revenue. AOL will likely have around 25 million U.S. subscribers and about $7 billion in revenue.

Narrowband access fees accounted for 85% of EarthLink's revenue compared to about 60% of AOL's revenue last quarter. Importantly, like AOL, EarthLink is growing high-margin advertising and commerce revenue. EarthLink had only $9 million of this revenue last quarter, up 275%, but it has an ad and commerce revenue backlog of $24.5 million and its Web properties are one of the "stickiest" for an ISP.

EarthLink will lose money the next few years, but in the past the company has demonstrated that it can be profitable. It is sacrificing profits now in order to grow market share, product offerings, and brand recognition. And it needs to! Brand recognition is something AOL has in spades over EarthLink. That said, AOL investors should not discount EarthLink's ability to dent AOL's broadband business and to build a stronger brand name for itself. Already a small leader in DSL, EarthLink is also slated to offer cable access on AT&T (NYSE: T) cable networks after 2002. Plus, EarthLink will spend tens of millions of dollars this year to market its brand as a reliable, customer-oriented service.

EarthLink may never topple AOL's ISP dominance, but it does stand to gain high-revenue, more experienced Internet users by focusing on the customer experience more than AOL may be able to. With over $1 billion in cash and, essentially, a singular objective, EarthLink is positioned to market itself as a company that listens to customers, while AOL will be focused on merging with Time Warner (NYSE: TWX).

At a recent $16 per share, EarthLink is valued at $2.5 billion, or about $715 per subscriber. The top dog, AOL, has typically been valued at around $1,200 to $1,600 per subscriber. In conclusion, AOL investors should keep an eye on EarthLink and especially on EarthLink's broadband business. And investors who own AOL and understand the ISP industry (and believe in it) may want to consider the number-two company, too.

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