MindLink to EarthSpring: Come In

The newly merged company will be in a stronger position to woo telecoms and battle the 'evil empire' of AOL.
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In February of 1998, a team of investment bankers urged the four-year-old ISP

MindSpring

(MSPG)

to merge with its rival

EarthLink

(ELNK)

. Main reasons: Expand infrastructure, cut costs and gear up to face bigger rivals.

With 300,000 subscribers (more than doubled from a year ago thanks to its strategy of acquiring smaller ISPs), MindSpring ignored the suggestion. After all, its stock had jumped 5-fold since its initial public offering a year earlier.

That was then, this is now. MindSpring said Thursday it will merge with EarthLink in a $1.4 billion pooling of stock. Sure both MindSpring and EarthLink shares now trade at roughly three times their levels of February 1998, but both companies are now hunting for traction in a fast-changing market.

Analysts say several key factors contributed to the timing of the deal, not the least of which are pressures from

AT&T's

(T) - Get Report

high-speed cable modem services and the presence of free-access ISPs.

As Internet connections become a commodity, consumers are being courted with other services besides just a simple link-up to the Internet. Customers are now being tempted into "bundled" deals involving local and long-distance rates as well as superfast Internet connections. The planned merger is good news for

Sprint

which would be the most likely candidate to offer EarthLink's 2.8 million subscribers packages of wireless, local and long-distance phone services. No wonder that Sprint, with two board positions and a 28% stake in EarthLink, voted enthusiastically for the merger, even though its stake will be halved to 14% after the merger closes.

Straight Internet access providers are under fire: Tomorrow

NetZero

, which has signed 1.7 million subscribers to free Internet services, expects to issue its first stock on the

Nasdaq

.

The leader that everyone is chasing is

America Online

(AOL)

. With over 18 million subscribers, AOL is keen to promote its rich content and ease of use to retain and grow its customer base. This summer, it has been busy cutting distribution deals with a variety of broadband companies, including the phone carrier

Bell Atlantic

(BEL)

.

With AOL dominating, the race is on for the No. 2 position. "Whatever urge they felt to merge a year and a half ago, it's that much stronger now," says Rob Norcross, vice president and telecom consultant with

Mercer Management Consulting

. "The cost of waiting is becoming more severe." By joining their assets and content, Norcross says, MindSpring and EarthLink become more alluring to telecom companies looking to expand their Internet offerings.

"Bundling may be a potent driver of the business down the road, but today it's who's getting subscribers right now," says Glenn Powers, an analyst with

Cruttenden Roth

, a Newport Beach, Calif., investment bank. Powers has a strong buy on EarthLink and Cruttenden was one of the underwriters of EarthLink's secondary offering in January.

By growing to critical mass first, MindSpring and Earthlink now can execute their merger with more firepower. Last year, says Earthlink CFO Grayson Hoberg, they never could have amassed the dollars for such a campaign. Analyst Ted Broomfield with

SoundView Technology Group

expects the combined companies to exert greater negotiating power with various telecom partners. His firm has no banking ties to either company.

But the merger is also a defense against AOL, say analysts. "EarthLink and MindSpring are focused on the same consumers at the same price with the same strategy," Powers says. "So the extent that any energy was spent by EarthLink fighting against MindSpring was just a waste of time. The real battle is against AOL for new users."

That is the view echoed by company executives. "We were the two leading rebel factions fighting the evil empire and we decided to join forces to create one giant rebel army," says Sky Dayton, 27, who founded Earthlink in 1994 and who'll be a director in the merged outfit.

Despite the tough anti-AOL talk, EarthLink plans to spend $300 million in marketing next year to edge out its closest rivals, AT&T

WorldNet

and

Microsoft's

(MSFT) - Get Report

MSN

. Ironically, Microsoft unveiled a new strategy for MSN Thursday to expand its reach and ease of use.

"Microsoft has been trying to find the right strategy in this space for a number of years," says Garry Betty, president and CEO of EarthLink. "So far, they haven't finalized a strategy that has consumers flocking to their banner."

The merger makes the new company "clearly the dominant No. 2 behind AOL," says Steve Smith, CEO of

OneMain.com

, which serves rural markets largely overlooked by other ISPs. But being second-best may not be good enough.