NetZero Picking Through the Bones

NetZero wasted little time swooping in to pick
through the bones of its chief rival, after the
privately-held no-cost ISP filed for Chapter 11 bankruptcy protection.
Pending approval by a bankruptcy court, FreeI users will be moved over to
NetZero’s free Web access while
maintaining their existing e-mail addresses. The deal is a continuing trend
toward consolidation in the free Internet access space, but this latest
land-grab is hardly what you’d call an encouraging sign for the future
prospects of the industry at large.

Mid-April marked the beginning of the current market turbulence and
not-so-coincidentally, marked the beginning of the end for FreeI. The
company filed for a massive $170 million IPO just two weeks ahead of the
Nasdaq’s slow leak. While terms of the offering were never made public, it
would have undoubtedly mirrored NetZero’s $160 million IPO in which the
start-up saddled retail investors with 10 million shares priced at $16 a
pop last year. Since then, the free ISP’s business model has fallen out of
favor with investors who’ve sent shares of NetZero to its 52-week low near
2-1/2 from a high of $40.

By all accounts, FreeI was a comparable me-too competitor that narrowly
missed its window to feast at the new issues trough. In August of 1999, the
company scored its first round of funding from Menlo Park-based Sequoia
Capital, in which the VC firm swapped $10 million in cash in exchange for
10 million shares. Three months later, online music provider
followed suit with an investment of its own. Shortly
thereafter, FreeI landed a mezzanine round of funding that valued the
company at a staggering $1 billion on paper.

At the turn of the new millennium, the newcomer was jockeying alongside its
publicly-traded rival NetZero as the largest privately-held free ISP,
boasting well over 2 million users. With NetZero attracting roughly 3
million users, while commanding a $1.5 billion market cap on Wall Street,
the road to a moonshot IPO for FreeI looked all but assured. But come
April, investors were openly questioning the frothy valuation and long-term
viability awarded to a company that earned just $12 million on losses twice
that amount.

Cracks were starting to show in the once-sexy business model of free
Internet access supported almost entirely on ad sales. In FreeI’s initial
SEC filing, the company admitted that of its more than 2 million
subscribers, only half had used the service within the last 30 days. That
suggested a trend that subscribers were likely using the service largely as
a secondary ISP or weren’t entirely satisfied with FreeI. Another key
concern was whether advertisers would even consider buying banner ads on a
service geared toward cheapskate consumers. The answers to prospective
investors’ questions weren’t adding up, and it was clear that FreeI’s IPO
prospects had become leakier than a wet paper bag.

FreeI waited until the eleventh hour to withdraw its IPO plans, filing just
a week later for bankruptcy protection. That’s a troubling thought when you
consider that the start-up was so eager to line its pockets with investors’
money despite the fact that the coffers had already long since run dry.
There’s little doubt that FreeI had likely approached NetZero about an
acquisition months ago, but the publicly-traded company wisely chose to
remain patient, waiting for bargain basement valuations. In this deal,
NetZero swings for the fences, boosting its user base dramatically and
eliminating its chief rival, all at dirt cheap prices. FreeI and its
investors, on the other hand, fall victim to poor timing and a sour market.
Put the two together, and I guess you can say this deal is, well, a net zero.

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