Internet 2001: ISPs Locked In War Of Attrition

Someday I’ll write a cheery piece about an Internet sector bursting with promising investment opportunities for value-hungry stock traders.

But it won’t be today, because we’re looking at ISPs/Access Providers, a sector facing major consolidation as countless struggling ‘Net service providers succumb to that toxic mixture of high overhead, tiny margins, deep losses and dwindling market caps.

The challenge facing the sector is that basic Internet access is becoming a commodity – at least in this country – hence the pricing pressure that leads to red ink and rapid cash burn.

And while high-speed access is still in great demand (market penetration is only about 5%), broadband ISPs are waging a bloody, losing war with powerful Baby Bells in the DSL arena.

Of all the Internet sectors, this may be the one where size matters most. After all, how can small ISPs serving local markets compete against America Online , which not only offers users worldwide unlimited Internet access for $21.95 per month, but also its own highly popular, user-friendly interface and exclusive content, not to mention popular services such as instant messaging? They can’t compete with AOL or Microsoft’s MSN on price, and they can’t outmarket them.

So smaller ISPs have been forced to adopt risky (and dubious) business models – free access – or carve out specialty niches. There’s PNV, which sought to be the premiere provider of Internet access to the nation’s truck stops. The company ceased operations last week after filing for bankruptcy protection in December. No wonder: In the third quarter, PNV had revenues of only $5.5 million, down slightly from the previous quarter – and a net loss of $18.2 million, or $1.14 per share.

Then we have Netpliance , which made a big splash with its I-opener desktop Internet appliance. The company’s strategy was to sell the device below cost and make a profit through monthly Internet access fees and e-commerce revenue. In December, an investor group led by Netpliance executives offered 65 cents per share in a bid to take the company private. NPLI was trading at 56 cents per share on Thursday, or 98% below its 52-week high of $26.13.

The free access providers, amazingly enough, have been unable to generate enough revenue to get into the black. NetZero , which gets its revenue from banner ads, direct marketing deals and e-commerce, has seen sales decline and losses grow ($28.9 million in Q3) for the last two quarters. Rival free ISP Juno Online Services barely grew revenue in Q3, though it did reduce its net loss to $29.3 million from $42.9 million in the second quarter.

Turning back to broadband, the losses incurred by many of these high-speed providers are staggering. , for example, had a net loss of $30.2 million in the third quarter (revenue was $5.9 million). In early December, the company announced it would lay off 28% of its staff.

Covad Communications , which offers DSL service to businesses and wholesale DSL service to other ISPs and telcos, lost an astounding $195 million in Q3 and announced this week that it is having trouble collecting payments from customers.

On the global front, I don’t know of any international ISP trading in the U.S. that is close to profitable.

So is there anything for investors to look at in the ISPs/Access Providers sector?

There’s AOL, if you want to consider it an ISP. It’s the largest access provider in the world and solidly profitable. And with the Time Warner merger finally being completed on Thursday, AOL now is a leading broadband provider, eliminating the one chink in its access armor.

Earthlink is one of the biggest revenue generators in the group, with $249 in sales for the third quarter. But it’s another bleeder, with a Q3 net loss of $72.5 million.


er, with the capital markets tight these days, only those access providers with large war chests will be able to survive the lean times. That means AOL and the large telcos. The pure-play ‘Net access providers have yet to prove they can survive, never mind thrive.

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