The EarthLink (ELNK) moved for investors on Monday. But the news about its high-speed Internet business wasn't as groundbreaking as it seemed, little rabbit.
The nation's second-largest Internet service provider in terms of subscribers will start offering high-speed Internet access in September to
AOL Time Warner
cable subscribers in Syracuse, N.Y., and Columbus, Ohio. The companies said they expect EarthLink's service will be in a "substantial" number of Time Warner Cable's operations before the end of the year.
The revelation that the Time Warner debut is still on schedule is good news for EarthLink, a 4.8 million-subscriber Internet service provider that's getting most of its revenue and subscriber growth from broadband Internet subscribers, not its traditional dial-up business. But because the number of potential subscribers is small, and the margins on broadband aren't quite wonderful yet, EarthLink has a ways to go before the news is as good as shareholders hope. EarthLink rose 91 cents Monday to close at $16.54.
To get a better idea of the deal's monetary impact on EarthLink, let's try to figure out how many people might sign up for the service.
Start with the number of cable subscribers AOL Time Warner has in Syracuse and Columbus: a total of 642,000, according to Time Warner Cable. How many subscribers to high-speed Internet services does that translate into? Well, there's no hard-and fast answer, in part because customers for broadband Internet don't necessarily have to be previously existing cable subscribers; they just have to be living in neighborhoods served by advanced cable systems.
But start with a piece of scratch paper and a few data points --
disclosure that it's in 8.4% of homes passed by upgraded cable systems,
Paul Kagan Associates'
estimate that 70% of homes that could subscribe to cable do -- and you end up with the not-unreasonable figure that 640,000 cable subscribers translates into about 64,000 cable modem subscribers in Syracuse and Columbus.
Will all those 64,000 subscribe to EarthLink? Of course not. After all, one of the reasons that AOL Time Warner is letting EarthLink on its system is that it's a condition for marketing high-speed
subscriptions on the same systems. So figure that EarthLink gets 32,000 subscribers -- ignoring additional competition from
Juno Online Services
( JWEB) and
High Speed Access
Except they don't all come at once. At
, for example, each year brings about 2 percentage points of penetration of high-speed cable-possible homes; in the back-of-the-envelope calculation for Columbus and Syracuse, that means that EarthLink's share is about 9,000 added customers a year.
That 9,000 per year, or 2,250 per quarter, is nothing to scoff at, but it's not huge in the grand scheme of things: Analyst Fred Moran of Jefferies, for example, estimates that EarthLink will add 65,000 broadband accounts this quarter to reach 353,000 total. (EarthLink is slated to release second-quarter numbers on Thursday morning.) Nine thousand subscribers, paying, say, $50 a month each for high-speed connections, represent around $5.4 million in revenue per year.
But how much of that $5.4 million will EarthLink get to hold onto? Thomas Weisel Partners analyst Peter DeCaprio, who initiated coverage on EarthLink last month, estimates that gross margins for EarthLink's broadband business are about 20% -- for now clearly less profitable than narrowband gross margins of at least 65%. That would mean that EarthLink would have only $1.1 million of the $5.4 million left after paying direct telecommunications expenses, starting with Time Warner Cable's cut of the subscription fee.
To put that $5.4 million revenue and the $1.1 million gross profit in perspective, compare them with Moran's 2001 estimates for EarthLink: $1.2 billion in revenue, an operating loss of $382 million, and an EBITDA loss of more than $35 million. It's not a lot of money in the grand scheme of things.
Of course, Syracuse and Columbus represent only a fraction of the Time Warner Cable market opportunity. Of course, EarthLink's broadband margins will improve. Of course, by 2011, cable modems could be in more than 50% of U.S. households, a possibility raised by DeCaprio in a June report. But, hey, we already knew that before Monday's announcement.