RealTime IT News

Juno/NetZero: A Study in Synergies

In a kiss-and-make-up tale worthy of the Oprah Winfrey show Thursday night, Juno Online Services and NetZero, Inc., announced their upcoming marriage at the end of the year.

But will the newlyweds be able to make it last? After all, those crazy kids have been in more than one tussle over patent infringements and the like in the past.

NetZero and Juno -- considered "free" ISPs even though both charge users for unlimited access to the Internet -- use a similar ad banner portal for their non-paying service. In fact, according to Mark Goldston, NetZero chairman and chief executive officer, the court proceedings over who is the rightful owner of the current banner ad technology will continue until the merger is completed at the end of the year.

"At that time we'll determine whether or not we want to sue ourselves," he joked to analysts in a press conference Friday morning.

The tone of the meeting was everything you'd expect to hear from the leaders of two large (though fairly unprofitable) national ISPs who are trying to convince investors (and doom-and-gloom media types) that the merger is a good idea. "Synergies," "high-octane" and "turbo-charged" are just some of the power words that were bandied about to analysts.

Charles Ardai, Juno president and chief executive officer, said that at first officials on both sides overlooked the two company's similar composition.

"The fact is, we've known each other for quite awhile as fellow participants in a market that has bigger competitors like AOL and Microsoft, and the more we got to know each other, the more we familiarized ourselves with each other," Ardai said. "The clearer it became that these are two companies that ought to be together, the more we looked at what Mark aptly describes as a marriage."

And on paper, the all-stock merger valued at roughly $70 million is a good one, although it's not quite the marriage executives are hyping. NetZero shareholders will own 61.5 percent of UOL while Juno shareholders receive the remaining 38.5 percent.

Many analysts, including Norm Bogen of online research company Cahner's Instat, expressed cautious approval of the merger.

"The merger makes sense because the combined companies will have a more significant installed base of customers, Bogen said. "However, I believe the merger was created because of weaknesses at both companies. Free Internet service is not a sustainable business model because advertising revenues are not sufficient to support it."

The two ISPs follow almost mirror-reflection business models with their bring-'em-in-for-the-free-service-and-get-them-to-sign-up-for-the-premium service. Juno has been doing longer, but both have been relatively successful convincing free users to sign up for unlimited hours and better service.

Combined, NetZero and Juno have more than one million subscribers to its $9.95 premium services. Juno paying subscriber numbers are hard to track, because they have run promotions running the gamut in price from $4.95 to $14.95.

Now that the two are together, they have relatively the whole free ISP market share under one tent, with the exception of K Mart's Bluelight.com. All told, UOL will boast more than seven million registered active users.

A combined user base of nearly 10 million users also gives the two ISPs considerably more marketing power than either had alone. The combination, Goldston said, will cut down on marketing costs considerably.

"It is important to keep in mind, the power of having a customer acquisition cost of about $100 per subscriber in a space that has exhibited $300, $400, $500, acquisition costs," Goldston said. "And, other than (America Online), there's no one out there that can match us. This advertising market will come back. And when it does we'll be in a strong position than we are in today."

Another synergy created by the merger of the two "mega-frees" is their dial up footprint. Both have contracts with backbone carriers like AT&T and UUNet for a fleet of POP servers, many of them in the same located in the same collocated buildings.

According to Charles Hilliard, NetZero chief financial officer, there is a lot of overlap in the two company's operations. On the technology front alone, the expected synergies are going to reduce the POP presence by 50 percent, when compared to the sum of the two parts.

On the broadband front, UOL will take its time when it comes to a nationwide roll out. Earlier this year, Juno announced it would be the second nationwide ISP, with EarthLink, Inc., to share space on AOL/TW's cable network.

While they consider its customer base a natural springboard for a vertical leap into the broadband arena, they are going to let AOL/TW take the lead in that department.

It's a very wise move for NetZero and Juno. After all, you have to consider the source: 85 percent of its customers are looking for a free ride and many of the rest had to be persuaded to move to the $9.95 deal.

"The cost structure of both the DSL and cable today would suggest that you cannot get stratified in that segment since it runs at a very high cost, both to the consumer and to the (ISP)," Hilliard said. "So, at this time, it would be premature, if not foolish, to get into a vertical stratification of that market segment.

"As it relates Juno, we think it's a great deal," Hilliard continued. "AOL Time Warner will clearly be the leader in power in that broadband space and I'm sure they will have a very high-quality system that they intend to build. This combined enterprise will have the opportunity to take advantage of that and be part of a broad scale cable roll out."

But it's not all synergy nirvana. It's going to take more than just a positive attitude and nearly six months to work out the kinks. Both companies have been plagued with the financial pressures that have put almost all the other free ISPs in the grave.

It costs money to power up a network, whether you're a free ISP or one that charges $22.95 per month. At some point, UOL is going to have to bring in serious money on a monthly basis to stay in business.

And although the combined entity will have more than $200 million on hand, officials already admit they are going to need $20-25 million to make it work. Of course, that's a figure based on the assumption that everything goes well.

That money won't last long if problems persist, like the continued dearth of advertising revenues and significant monthly capital cash burns. In the last quarter of 2001, both reported a combined burn rate between $26-38 million. Add that to the expected restructuring costs, and $200 million doesn't look like too much money.

For now, though, the two ISPs have made a good start.

While UOL will act as an almost corporate shell for the two companies, Goldston will run the show: Ardai will stay with the company only as a shareholder.

Juno, for the time being, will act as the combined company's paying subscriber arm of the company, while NetZero, for the time being, will act as the free ISP. It's Web sites, Goldston promises, will make choosing between the two services very simple and evolve into a UOL whole next year.

For the most part, investors applauded the merger plan, showing its pleasure in the form of stock gains. At one point, Juno shares surged to $2.03 before settling 30 cents up on the day, while NetZero (which will gain the lion's share of control in the combined entity) climbed 22 cents per share to $1.17.

What happens next is anybody's guess. A year from now, the skeptics are going to be either making gloating pronouncements of their wisdom or relegated to confused muttering in the background.

Regardless of the outcome, both ISPs should be allowed to enjoy their honeymoon while it lasts.