Free worked for television. But can it work for the Net? The Internet service provider industry is still struggling to figure that out. More than 10 million people have signed up for free Internet access from four well-funded operations over the past year. Though these ventures' ultimate success is still unclear, their potential impact on the industry isn't: With any success, they easily could nibble at subscriber growth and margins at industry stalwarts such as America Online ( AOL), which has 18.6 million domestic subscribers, and EarthLink ( ELNK), which, with last week's deal to acquire ISP OneMain.com ( ONEM), will end up with 4.2 million subscribers. Whether the free ISPs can succeed appears to be a question best-answered by watching NetZero ( NZRO), the only publicly traded ISP that thinks it can make a business purely out of connecting Americans to the Internet for free. With its stock down 80% from its December high, the company is encountering the same skepticism confronting other cash-burning Internet companies. But if it can pull off its business plan, it could lead free Net access out of its niche.
Giving It AwayNetZero, which has lost $64 million since mid-1999 in its attempt to build the free-ISP business, has distinguished company. Since last fall, at least three other free Internet access services have launched in the U.S.: Kmart's ( KM) BlueLight.com, AltaVista Free Access, operated out of CMGI ( CMGI) subsidiary AltaVista, and an offering from Juno Online Services ( JWEB), which markets a combination of free and paid Internet connections. Combined, these three services have signed up more than 6 million freeriders.
|ISP Stocks Take Their Knocks |
Costs AplentyOf course, telecom costs aren't the only costs. You've got marketing expense, because if you're in a hurry, you have to advertise your product, even if you're giving it away. You've got to hire a staff of salespeople to go out and sell advertising and e-commerce deals for the ads. You need another set of people to run the computers. Goverman thinks it will be 2002 at the earliest before NetZero can generate positive cash flow from operations. NetZero might even have the cash on hand to get it that far. In late April, Qualcomm ( QCOM), which had already launched its own foray into ad-supported Internet through a new version of its Eudora email program, announced it was buying a 10% stake in NetZero for $144 million. Add that money to NetZero's unrestricted cash and securities on hand at the end of March, and you get a company with $270 million in the bank. That, says Goverman, should be enough to finance NetZero's operations until it starts generating cash from operations. But the path could be bumpy, not just because Juno earlier this month filed suit against NetZero and Qualcomm for patent infringement related to the ad-supported Eudora. One naysayer is EarthLink President Mike McQuary, who thinks the only way an ISP can make money is the old-fashioned way: charging for access. "Advertising revenues aren't growing fast enough. Telecom costs are coming down fast enough," he says.
Suspect Model?As recently as three months ago, says McQuary, EarthLink investigated the free ISP concept on its own behalf, but the numbers didn't add up. And he reaches the same conclusion looking elsewhere. "AOL is the best company in the world in getting nonaccess revenue," he says, pegging it at between $6 and $7 per subscriber each month. Meanwhile, AOL's telecom costs are more than $5 per subscriber per month, McQuary says. Add in all the other costs of running an ISP, and the model doesn't work, he says.
|How Much Is That ISP in the Window? |
Price/sales ratios for Internet service providers
|Company||Market Capitalization (millions)||Price/Sales|
|America Online (AOL)||$125,208||19.9|
|Prodigy Communications (PRGYA)||764||3.5|
|Juno Online Services (JWEB)||435||6.6|
|Sources: Market Guide, company filings.|