EarthLink Aims to Be Provider of Services Beyond Dial-Up Internet

EarthLink Inc. Chief Executive Garry Betty can understand why some on Wall Street may be down on his company.

After all, EarthLink built its business on a vanishing customer: dial-up Internet users. More people are switching to broadband, yet EarthLink doesn’t control its own high-speed network the way phone companies and cable operators do. And revenue is falling alongside the subscriber base.

Betty understands Wall Street’s worries, but he doesn’t accept any of them.

“The general misperception is that EarthLink is a premium dial-up company and that our business is going away,” he said.

Instead, Betty is overseeing a transformation of the Atlanta-based company that will take it far beyond its core business of providing Internet service.

EarthLink is building high-speed wireless networks, launching a cellphone business, rolling out land-line phone service and pushing into the business market -- all without alienating its shrinking but still-sizable base of residential dial-up customers.

In some ways, the challenges facing Internet service providers hark back to the early days of the company, founded by Los Angeles entrepreneur Sky Dayton in 1994 when hundreds of ISPs battled one another for business and few people really understood the market.

“The nature of consumer ISP service is continuing to morph over time,” Betty said. “Cable is trying to do voice, and telephone companies are trying to do video. I don’t recall a time so unsettled, but it’s also a time of great opportunity. These markets are so large that if we get just a small part, we’ll do fine.”

Some analysts, such as Vijay Singh at William Smith brokerage in Denver, see room for EarthLink as a niche player amid phone and cable giants such as AT&T; Inc. and Comcast Corp. EarthLink remains the nation’s largest independent Internet service provider, with 5.3 million customers.

“A lot of people are interested in the stock,” Singh said. “It was left for dead, and now it’s slowly showing signs of life.”

EarthLink shares rose 47 cents Friday to $11.56. The stock has lost 5% from its 52-week high of $12.21 on Jan. 13, but is up 39% from its 52-week low of $8.32 in April. During the go-go days for high-tech firms in the late 1990s, EarthLink shares closed at a record $62.47, adjusted for stock splits.

This month, EarthLink said fourth-quarter profit fell 18% compared with a year earlier to $29.2 million. Revenue fell 7% to $312.6 million. But for the year, profit rose 29% to $142.8 million as revenue slid 7% to $1.3 billion.

Many investors, though, see more trouble in subscriber numbers. The company lost 300,000 dial-up customers last year. Despite gains in broadband, EarthLink’s net subscriber base fell by 73,000.

“Its most profitable business is in decline ... and it’s going into areas where it is late to market and has a lot of competition from some well-capitalized firms,” said analyst Jim Friedland at SG Cowen & Co. brokerage in San Francisco. “The company wasn’t in dire straits last year, but it’s not necessarily in better shape this year.”

Betty is undaunted by the prospect of entering crowded markets, noting that EarthLink thrived in the face of competition from Time Warner Inc.’s America Online and Microsoft Corp.’s MSN.

“As long as we have the opportunity to offer alternatives and options, we’ve demonstrated our ability to compete,” he said. “We’re not shrinking away from that.”

More importantly, Betty and analysts point out, EarthLink doesn’t have to be the market leader to develop a solid, profitable business in each new area.

“They just need to get 2% [or] 3% of the market share they didn’t have,” analyst Singh said. “I don’t really see much of a downside.”

EarthLink’s first big bet is delivering broadband wireless networks to larger cities nationwide. Last year it won the hotly contested bidding to install a high-speed network in Philadelphia and, two months ago, it won a contract to set up a system in Anaheim that is being built and should be ready this summer.

In Long Beach, EarthLink’s offer to put up a wireless network helped prompt the city to redo its request for eight more hot spots and, instead, seek a citywide system. The company also is targeting such cities as San Francisco, Chicago, Atlanta, Milwaukee, Minneapolis and Portland, Ore.

“If we got everything we wanted, we could spend a couple hundred million dollars in 25 cities,” Betty said. “The key is to have a certain density of homes to allow service at about $40 a household.”

That comes to about 2,000 homes per square mile, he said.

Building its own wireless network helps EarthLink hedge its bets. Over the next five years, the U.S. broadband market will grow by two-thirds to reach about 71 million homes, or 79% of all households with online service, according to industry analysis firm Forrester Research Inc.

But EarthLink has no high-speed lines of its own. It has to rent them from phone companies such as AT&T; and Verizon Communications Inc. Although it has some new contracts in hand, the process could get tougher if the phone companies take advantage of new federal rules that let them bar others from leasing those lines.

EarthLink can’t lease high-speed cable networks except from Time Warner, which must open its system under terms of its acquisition of AOL.

With no debt and a cash stockpile of $400 million, EarthLink has the flexibility to try new technologies, Betty said.

“Whether they’re successful or not, only time will tell,” Singh said. “But at least they won’t be accused of just sitting there.”

EarthLink also is betting on its cellphone partnership with SK Telecom Co., South Korea’s largest wireless operator. Each company is putting in $220 million, including $40 million in existing products and customer base from EarthLink.

The joint venture, called Helio Inc., is based in Los Angeles under the leadership of EarthLink founder Dayton, who also is an EarthLink director.

Leasing network capacity from Sprint Nextel Corp. and Verizon, Helio plans to market its service and handsets this spring to tech-savvy youth.

“We’ll have very high-end handsets, stuff from Korea that’s never been here before, and services that take full advantage of [higher-speed third-generation] networks,” Dayton said.

Last week, Helio unveiled two Asian-made handsets with bigger screens and a service that will let users read and post to MySpace.com, the social networking site that is hugely popular among teenagers and young adults.

SK Telecom owns the South Korean equivalent of MySpace, called CyWorld, which users there already can access on their cellphones.

“Helio is for those of us who want a badge of personality, not a phone; a mobile lifestyle, not a utility,” Dayton said. “The true power of wireless is about communication, about connecting us to our friends when we’re out living life.”

Throughout much of Asia and Europe, cellphone users are far ahead technologically of U.S. subscribers, who use cellphones primarily to talk and send messages. South Koreans already can use their cellphones to engage in multi-player games and buy services and products, Dayton said.

“They wave their cellphone at a subway tollbooth and automatically pay the fee,” he said. “If you compare wireless in the U.S. with wireless in Korea, we’re living in the past.”

There are more than 200 million U.S. cellphone users now, and Betty figures Helio can pick up 3 million customers and garner $2 billion in annual revenue by 2009.

EarthLink’s third prong is the Internet version of regular phone service. Through a technology known as voice over Internet protocol, the company now offers phone service through a computer as well as Internet-based phone service through a broadband connection.

In addition, EarthLink recently started working in four major cities with Covad Communications Group Inc. of San Jose to use conventional copper lines to sell Internet-based phone service and very fast broadband service -- without the ubiquitous modem -- for $70 a month.

Betty figures that if EarthLink can capture 1% of the voice market by bundling phone and broadband service, the company would get an added $700 million in revenue. “That allows us to play in a much larger pond,” he said.

EarthLink’s latest venture is its effort to serve small and medium-sized businesses. Its pending $144-million acquisition of New Edge Network Inc., which provides virtual private networks for businesses, would give it access to nearly any company in cities and small towns across the country.

Betty isn’t worried about following through on all of EarthLink’s plans. There will be bumps along the way, he said, but all the technologies work. And the company’s forte is executing its plans.

“That has been our success for the past decade,” he said. “Anything we’ve said we were going to do, we’ve done.”