Rumours of ISP industry tryst for EarthLink and MSN
Published: 13 Feb 2001 11:30 GMT
The recent suspicion that Microsoft may be courting number two Internet service provider EarthLink lends further evidence that the software giant's Internet strategy has fallen short of expectations.
In the aftermath of Earthlink's strategy alteration with long-distance giant Sprint, several signs point to a possible partnership between Microsoft's MSN dial-up Internet access service and the company. Industry analysts say a tie-up could behoove both companies in their battles with online giant AOL Time Warner.
Microsoft has spent heavily to close the gap between its 4-million-subscriber MSN service and America Online, the world's largest ISP. A pact with EarthLink would more than double MSN's customer base. For EarthLink, Microsoft's involvement could lend further credibility with consumers, greater access to PC maker partnerships and promotional power.
"When you look at AOL with 27 million customers worldwide and you look at number two and number three, they're a long ways back," said Alan Mosher, an ISP analyst with industry consultants Probe Research. "The only way you can start to compete effectively is to grow quickly. By combining number two and number three together you start to become more attractive to advertisers and e-commerce companies."
AOL's incredible subscriber growth and the close of its merger with Time Warner poises the company for further expansion into high-speed Net access, which is expected to be the industry's next area of growth. The company already is the clear leader in Internet brand awareness among consumers and demands a significant portion of online advertising and e-commerce dollars.
The struggle in recent years between second-tier ISPs, such as EarthLink, MSN, Juno Online Services, AT&T WorldNet and NetZero, a free provider, has done little to establish a clear-cut challenger to AOL's supremacy. But a partnership, or even a merger, between two of the next-largest players could change all that.
Citing a number of factors, some analysts believe a deal between MSN, Microsoft's Internet unit, and EarthLink is not just a possibility but likely.
"Based on several recent developments, we believe a strategic transaction between EarthLink and Microsoft may be imminent," said Frederick Moran, an equity analyst at Jefferies & Company, in a research report last week.
Specifically, Microsoft recently ended its $400 rebate offer for new Internet access customers. The program helped attract customers, but at a cost to Microsoft's bottom line. A deal with EarthLink would quickly more than double MSN's subscriber totals without the need for costly rebates or other marketing programs, Moran contends. EarthLink has 4.7 million subscribers, second only to AOL Time Warner in terms of paying customers.
Additionally, Moran believes recent changes to EarthLink's partnership with Sprint were made with a third-party acquisition or partnership in mind.
Microsoft representatives declined to comment on the rumour, saying talk of a MSN-EarthLink deal is merely speculation. EarthLink representatives declined to comment specifically on the rumours of a deal with MSN, but did add some insight into the changes in its pact with Sprint.
"The Sprint deal definitely opens doors that were closed before," said an EarthLink spokesman. "This allows us to talk to people that wouldn't have talked with us before because they thought we were sort of married to Sprint. There were a lot of governance things that intimidated a lot of people. Now they're all gone."
For Microsoft's part, the software company was notoriously late to the Internet party and has spent years and millions of dollars playing catch up.
"They've dumped a ton of money into trying to become another AOL and they're no where near that," Probe's Mosher said.
An acquisition of EarthLink would boost MSN's subscriber rolls without the need for costly rebate plans. EarthLink is currently trading at about $200 per subscriber, while Microsoft was offering rebates of $400 just last month. A takeover valued at $400 per subscriber would place EarthLink at about $15 per share, Moran said.
But other analysts doubt EarthLink management would be willing to sell, and certainly not for a price lower than the mid-20s per share. "I don't buy it," said Jeff Sadler, an equity analyst at FAC/Equities. "I think EarthLink is more of an acquirer than an acquiree."
Citing market speculation rather than sound fundamentals, Sadler cut his rating on EarthLink to "neutral" from "buy" after EarthLink shares gained about 30 percent since late last week. 0 EarthLink says its strategy is to continue offering dial-up Internet access and selling that access on a wholesale basis to other providers, but also offering broadband and wireless options.
Analysts agree that a combination of, or partnership between, two second-tier ISPs would quickly create a challenger to AOL. But a couple of factors could thwart any deals involving EarthLink.
For one, there is no love lost between Microsoft and AOL. But EarthLink has a cable access deal with AOL Time Warner that would allow the ISP to deliver high-speed Net access via cable modems. It is unclear how that pact might be affected by an acquisition of EarthLink.
Secondly, Sprint, though it no longer has seats on EarthLink's board of directors, owns a 27 percent stake in the ISP and has the right to refuse any acquisition offers for EarthLink.
Some analysts believe the plethora of competitors with low stock prices and foundering free ISPs could present EarthLink with an opportunity to buy a rival for a song. But other observers suggest EarthLink could benefit from a new deep-pocketed partner.
"It's more imperative to EarthLink than to Microsoft. MSN's got the whole of Microsoft behind it -- I don't think EarthLink has those kinds of options," Mosher said. "I also think that MSN's got good consumer brand awareness. I think EarthLink would gain visibility if they got together.
"I don't think EarthLink has the kind of money to do the types of things Microsoft can do," he said.
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