Broadband Push Gooses Growth at EarthLink

EarthLink (ELNK Quote - Cramer on ELNK - Stock Picks) is edging closer to breakeven cash flow, though its gross margins continue to slip during its migration to broadband.

For the second quarter ended June 30, the Internet service provider trimmed its bottom-line loss, meeting analysts' expectations. In its quarterly financials released before the market's open Thursday, EarthLink brightened its full-year 2001 guidance for earnings before interest, taxes, depreciation and amortization.

But the costs of providing high-speed Internet access -- the growth story behind EarthLink's more than 200% rise this year -- dropped gross margin to 58%, from 63% a year ago and 59% in the first quarter.

The trends highlight some crucial, yet unanswered, questions for EarthLink investors: For starters, how long will it take for the emerging broadband business to improve? And will its returns justify the cost of supplying service?

Investors were optimistic Thursday, sending EarthLink shares up $1.29 to $16.24.

For the second quarter, EarthLink reported revenue of $303.8 million, up 32% from $230.9 million in the second quarter of 2000. The company added 58,000 broadband subscribers in the quarter, bringing its total to 346,000 and lifting broadband revenue to $40.6 million from $10.4 million in the year-ago quarter.

Bringing down costs relative to revenue in several areas, EarthLink reported a cash-flow loss of $8.2 million for the quarter, better than the loss of $18.6 million in the first quarter and $32.7 million a year ago. Net loss for the quarter, excluding acquisition and merger-related costs, was $35.1 million, or 27 cents per share, matching expectations of analysts surveyed by Thomson Financial/First Call. That compared with a net loss of $35.2 million, or 29 cents per share, a year earlier.

EarthLink still expects to become EBITDA-positive in the fourth quarter. The company improved its EBITDA outlook for the year from a range of a $35 million to $50 million loss to one of a $17 million to $20 million loss, compared to an EBITDA loss of $158.8 million in 2000. The company says its net loss, excluding certain items, will be around 80 cents to 95 cents per share for the year, a more optimistic range than its prior indications of a loss in the area of 85 cents to $1.05 per share. The corresponding figure was a $1.45 per-share loss in 2000. (EBITDA, or earnings before interest, taxes, depreciation and amortization, is a cash flow measure Wall Street uses to gauge performance at money-losing companies.)

"They turned in a very consistent performance -- one of the hallmarks of EarthLink," says CIBC World Markets Internet/digital new media analyst John Corcoran. "They definitely showed very strong cost controls."

Corcoran, who initiated coverage on EarthLink earlier this month with a strong buy rating, acknowledges it will take time for EarthLink to show meaningful improvements in gross margins. "We're talking at least three, four quarters," he says. But, he suggests, the payoff will be worth it, because the broadband business brings with it higher per-customer revenue than conventional dial-up business; lower customer churn, or turnover; and a greater opportunity to add services, perhaps related to online music or home networking.

Corcoran says he believes that the lifetime value of a broadband subscriber is greater than that of a dial-up, or narrowband, subscriber. The analyst says that fact justifies EarthLink's paying $200 to acquire each broadband subscriber, compared to $150 per new narrowband subscriber. Corcoran, though, declined to estimate lifetime values for either dial-up or high-speed access subscribers. His firm hasn't done any underwriting for EarthLink.