Earthlink-Mindspring: Fighting the Death Star

The ISP (Internet Service Provider) business is perfect for consolidation.
First of all, the service is becoming a commodity. Second, there are many
mom-and-pop operators (about 7,000). Finally, to make money in the
business, scale is essential — which
America Online Inc. (AOL)
has proven.

Despite all this, the ISP market has been slow to consolidate. But this
should change quickly, in light of yesterday’s blockbuster deal between Earthlink Networks (ELNK)
Mindspring Enterprises (MSPG)
(the new entity will be called Earthlink and the ticker symbol will
remain ELNK).

Two main factors that have ignited the consolidation wave:

1. The Free Model: For consumers, it is compelling to use free ISP services
versus those that are based on monthly subscriptions. Within a year,
various free-based ISPs have been amassing substantial user bases. NetZero,
for example, has 1.7 million users. Then there is Freei Networks, which is
owned by CMGI and should benefit greatly from the AltaVista purhcase (that
is, the cost of acquisition of new customers should be quite low).

The free-models will ultimately place much pressure on the fee models.

2. AOL: The founder of Earthlink, Sky Dayton, likes to refer to AOL as the
Death Star. And he’s right. With 20 million subscribers (counting
CompuServe customers), AOL is seemingly unstoppable.

With its financial resources, AOL has the luxury of enlarging its virtual
empire. This week, the company announced it would spend as much as $10
billion to get into people’s homes via cable, enhanced phone lines,
satellites and wireless technologies.


Taking a look at the Earthlink deal, it makes lots of sense. Instantly,
they will create an ISP with 3 million subscribers. This puts them ahead
of AT&T, which has 2.5 million and MSN, which stands at 1.8 million. That
is, Earthlink will be No. 2 in the US.

Earthlink plans on spending $300 million on advertising over the next year.
The goal is to reach eight million customers by the year 2001. What’s more,
by merging the operations, Earthlink will derive cost efficiencies, as well
as negotiate better content and ecommerce deals, because of the its
enlarged user base.

Here are the valuation metrics of the ISP space:



Market Cap



Market Cap/User




 $   87.50

 $  96,000.00

 $  4,777.00


 $        4,800.00


 $   42.38

 $    3,500.00



 $        1,166.67


 $   17.56

 $    1,000.00



 $        1,631.32

 $   15.75

 $      355.00

 $      52.00




 $   10.00

 $      139.00

 $      27.00




 $   16.00

 $    1,632.00

 $        4.60




 $    3,126.00


Note: As of this writing, NetZero
is not public. I’m using a valuation based at a 40%

premium to the offering price of
the upcoming IPO


The chart shows how important a customer base is for valuation. As you can
see, the difference between the market-cap per user of AOL and Earthlink is
a stunning $3,633.

Even if Earthlink purchased Prodigy,, FlashNet and NetZero,
this would only double the customer base. But this would be difficult at
Earthlink’s current market cap.

As it stands, Sky Dayton is right. AOL is the Death Star. And I think the
only hope with the Earthlink-Mindspring merger is that they will prep
themselves to be bought by a much bigger company — say a telco or even AOL.
If not, then Darth Vader will win.

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