Qwest: An Example of What to Do When Only "Bad" Choices Are Available

Sometimes a company might find it has only bad choices available to it. For Qwest, that might arguably be said to be case. Faced with huge debt burdens, Qwest sold off its high-growth wireless business and then spun off its cable-TV division.

The moves allowed U S West to trim debt, avoid expensive capital investments and maintain the healthy dividends long associated with a traditional telephone operator. But those moves also made a growth strategy nearly impossible, since other arguably comparable larger telcos such as AT&T and Verizon used wireless to underpin most of their growth over the last decade, while video services now are starting to be a material factor for the fixed services business.

From a short term financial perspective, divesting those assets was helpful, but strategically ensured that Qwest would not have the industry-standard growth drivers of wireless and video. Of the two, the lack of a wireless offering was most significant.

To be sure, Qwest had other problems. Its service territory was the least dense of any of the former Regional Bell Operating Companies, which would have been an issue even if Qwest had retained its wireless and video assets.

Nor will Qwest be the last company to face the problem of having only tough choices to make. That doesn't mean a firm cannot harvest the returns from a declining business for a time. That is precisely what EarthLink is doing, for example. But there is no long-term future.

Qwest, and many other firms in telecommunications, likely face issues not quite as severe as EarthLink does, but with the same limited set of strategic options. Communications remains a scale business, so the largest firms have had an advantage in both wireless and video. The largest firms also will have similar scale advantages for the next wave of potential innovations as well.

Though access providers of all sizes face some fundamental issues, such as their place and power within the Web and Internet ecosystems, wired services providers face such issues most acutely.

Sky Dayton Leaves Helio

Given that Sky Dayton now has resigned as chief executive of Helio, the wireless joint venture between SK Telecom and Earthlink, one has to conclude that Dayton, at least, thinks the end is near. Shutting Helio down is a possibility, though not the only possibility. Earthlink itself is for sale and it is possible Dayton sees the larger transaction coming.

Earthlink clearly wants out of the Helio venture, but SK Telecom clearly believes in the business, hoping only to replicate the success it has had in its home market. The issue rests with SK Telecom, as the Korean firm recently invested $70 million in Helio and now has voting control of the venture.

Maybe Earthlink executives have found a way to reorganize the firm in a self-sustaining way. If so, it almost certainly would have concluded that it must stop investing in the muni Wi-Fi and Helio ventures.

Firm Acquires 10 Percent of EarthLink

Steel Partners, a New York-based investment firm, has acquired nearly 10 percent of the shares of EarthLink Inc., or 11.9 million shares. Steel Partners said the total purchase price of the shares is $97.3 million.

Steel Partners is controlled by Warren G. Lichtenstein, a young corporate raider and associate of investor Carl Icahn. Steel Partners may now be EarthLink's largest shareholder.

Sale Ahead for EarthLink?

EarthLink Executive Vice President Mike Lunsford, who acted as interim CEO after the death of former CEO Garry Betty, is leaving the company at the end of the year. Earthlink CTO Jon Kerner also is said to be leaving, as is Vice President of Production Operations Eric Alfaro. Kip Morgan, former EarthLink Vice President for Direct Marketing, Access and Audience, also has gone elsewhere.

When such things happen, one normally expects a sale of assets, which is what many observers expected when Rolla Huff took over at EarthLink.

EarthLink Wants to Sell Municipal Wi-Fi Assets

EarthLink is considering "strategic alternatives" for its municipal Wi-Fi business, says Associated Press, a phrase that generally means it is for sale.

EarthLink originally had hoped it might be able to come up with a revised business plan that relied on additional investment by partners, including the municipalities that wanted the networks in the first place.

The company "decided that making significant further investments in this business could be inconsistent with our objective of maximizing shareholder value," says Rolla Huff, EarthLink CEO.

NetZero Shuts Down VoIP Service

NetZero Voice, the VoIP-over dial-up service sold by NetZero, is being shut down by Dec. 15. Customers who want to migrate to the Packet8 service can do so for $19.95 a month.

Since 2005, NetZero had gotten only had about 12,000 subscribers, it appears. Former NetZero customers might be a mixed blessing for 8x8, though, which now focuses on VoIP services for small businesses. One has to believe most of the NetZero customers are consumers with a high value orientation, possibly similar in profile to the high-churning value customers EarthLink has to contend with.

So not only are the potential new customers outside the desired customer segment 8x8 is chasing, they probably are high churn customers as well. Time will tell.

SK Telecom to Carry Helio

SK Telecom says it will invest up to an additional $270 million to support Helio, effectively signaling that Earthlink will not be investing further in the joint venture. So the issue is how Earthlink can exit the joint venture.

ISP Subscriber Growth Favors Tier One Providers

Not that anybody should be surprised by the latest ISP subscriber figures, but large tier one telco and cable providers are racking up more market share while independent mass market providers are losing share. The one countervailing trend is that providers focused on the small and mid-sized business, such as Covad, continue to grow.

For those of you familiar with the SME space, it is, always has been and always will be a fertile segment for independent providers of all sorts. The latest ISP figures only confirm that observation, again.

Has Muni Wi-Fi Missed the Window?

Municipal Wi-Fi arguably had a market window within which it had to get traction or lose out to cable companies and especially telcos. With EarthLink now backing out of the remaining deals it originally negotiated, that window could slam shut. That isn't to say there might not be some niches it could fill, but they will be smaller niches.

The higher end part of the fully mobile market will be able to buy fourth generation mobile services, broadband based on 700 MHz spectrum, WiMAX and 3G broadband services. The tethered part of the market will simply find cable modem, Digital Subscriber Line and fiber to home services too attractive to ignore as well. The out of office portion of the market increasingly can use T-Mobile hotspots, hotel Wi-Fi and airport Wi-Fi.

Clearwire and satellite broadband are going to make more sense in most rural markets, though independent ISPs continue to offer basic tethered access using Wi-Fi technologies adapted for more focused line of sight deployment.

Wi-Fi had to get into place before WiMAX arrived, and it looks like it simply is too late to be a sizable mass market access opportunity. That isn't to say hotspots are not a business at all; simply that it is a niche.

That said, sizable niches do exist for providers of satellite broadband in some segments of the market. WildBlue, ViaSat, Gilat and HughesNet prove that the niche exists. And Spaceway might someday create additional niches in the smaller enterprise market as well. Wi-Fi, though perhaps not of the muni variety, might continue to provide such a niche.

EarthLink San Francisco Network Now Toast

EarthLink will not be providing free wireless Internet access throughout San Francisco. As promised, EarthLink is not proceeding with any new muncipal Wi-Fi networks when it has to pay the full cost of construction, as would have been the case in San Francisco.

Under the original deal, EarthLink would have invested $14 million to $17 million to build the network. EarthLink also expected to be able to charge $22 a month for a premium tier of service.

San Francisco officials probably will issue another proposal request. And EarthLink conceivably could get additional sponsors. But it's getting tough to make the numbers work when tethered broadband rates now are so affordable. In cities where muni Wi-Fi networks are in operation, or have been proposed, it isn't unusual to find tiers of service comparable to Wi-Fi available for $10 to $15 a month.

Also, as video becomes a more important part of the Internet experience, muni Wi-Fi networks just aren't going to be able to keep up.

No Bidders Left for Chicago Wi-Fi

Chicago has failed to reach agreement with either at&t or EarthLink, each of which had proposed building a municipal Wi-Fi network for the city. Just a few years ago, backers were arguing a business case could be made for either ad-supported free service or for-fee service at rates of $20 a month. But that was before U.S. telephone companies got serious about broadband pricing and dropped access costs behow $20 for service very comparable to what muni Wi-Fi networks were supposed to offer.

at&t charges $20 a month for speeds of 1.5 megabits a second in Chicago and will provide connections half that fast for $10 to new subscribers. In other cities such as Houston, an 800 kbps connection can be purchased for about $15 a month.

In Lompoc, Calif., the city signed up fewer than 500 users out of a population of more than 40,000.

So it looks like we are nearing the end of the muni Wi-Fi craze. Though some networks, primarily for public safety and municipal operations, might still be viable, it doesn't appear that most municipal Wi-Fi networks will prove commercially viable outside high-density urban cores.

And even there, how hard is it to find a T-Mobile hotspot at a Starbucks?

Ex-EarthLink Employee Site Created

If you are an ex-EarthLink employee, or soon to be one, this new site has been created for you.

http://exlinkers.blogspot.com/

EarthLink Pays Houston Fine; Might Be Off the Hook

EarthLink is paying the city of Houston a $5 million penalty fee for missing its first deadline in building the city's municipal Wi-Fi network. The payment might ultimately let EarthLink off the hook for the entire network build, though technically the payment buys about nine months to begin construction. The contract calls for complete construction time of two years.

Of course, EarthLink already has said it is no longer interested in continuing under the original contract terms, so unless the contract is renegotiated in some way, the network won't be built, at least not by EarthLink. It might not be the last fine EarthLink pays.

The city of Houston is also free to take proposals from other vendors during the nine-month period, and could award the contract to another company, observers say.

Considering that at&t offers Houston residents a $15 Digital Subscriber Line service running at 768 kilobits a second, it's hard to see how much share EarthLink might get for a service that will wholesale to retailers at $12 a month for a 1 Mbps service. The retail price then likely will have to be set at $15 or more.

EarthLink: Except for Helio, New Course Set

Saying it has made no final decision about its Helio investment, EarthLink officials have made a few things clear. It simply won't proceed with municipal WiFi networks in Alexandria, Va.; San Francisco; Atlanta; Houston, St. Petersburg, Fla. and Arlington County, Va. unless the terms of those franchises are altered.

It will continue to operate or invest in the networks in Corpus Christi, Tex.; Philadelphia and Anaheim, Calif.

What EarthLink is looking for is risk sharing by other stakeholders, possibly including the municipal governments, chipmakers, network infrastructure vendors or other stakeholders who benefit from continued deployment of municipal WiFi networks. In other words, EarthLink simply won't build if it has to put up all the cash.

For those of you who wonder about the business case, EarthLink is voting with its own wallet: there isn't an adequate return when it has to build the network.

So far at least, EarthLink seems to have made no final decisions about its Helio wireless venture, either. The problem is that EarthLink already has invested more than $100 million into the joint venture with SK Telecom, and it will watch that investment go down the drain if it doesn't try to get it into gear.

At any rate, Helio does not seem to be "top of mind" for the EarthLink management team. That belongs to the business-focused networking business of its New Edge Networks division. Getting New Edge to profitability is job one.

Among the current problems: gross margin of just five percent and churn of 2.7 percent a month. Of those two problems the bigger issue is gross margin. Monthly churn of 2.7 percent, while not pleasant, isn't terribly unusual in the small and mid-sized business market. But five percent gross margin is not a business.

EarthLink also is cutting back its customer acquisition efforts, and doesn't necessarily think it will be a bigger company in the future, measured by subscriber count. Instead, it will focus on selling more products to its existing base of customers.

That doesn't preclude acquisition of customer bases that are stable. EarthLink always has been an acquirer of customer bases, so that's in keeping with its legacy. But after a careful analysis of its customer cohorts, it has found what just about every other company with a recurring services revenue model also should find.

And that is that most of a company's churn occurs very early in a customer relationship. A good chunk--perhaps as much as a third or more of total churn--occurs within a few months. Perhaps half of all churn happens in the first year. Get past that point and churn actually is pretty low.

So the municipal WiFi decision essentially is made. For the markets not yet built, get concessions or get out. Run the three networks already operational. With immediate attention focused on New Edge, and different customer management straegies in place for the consumer Internet access business, that just leaves Helio unresolved.

What EarthLink Didn't Say...

..in announcing a cut of 40 percent of its current workforce, a tactical move, was what it intends to do about a business strategy with no focus. And that was what EarthLink remains mum about. Helio and municipal Wi-Fi are bleeding cash; broadband is slowing and dial-up is dying.

One thing EarthLink did say is that gross subscriber additions will decelerate in 2008, in part because EarthLink will stop marketing to customer segments it believes likely to churn.

There's something else. The company expects fewer migrations from narrowband to broadband. Why? Because, industrywide, the pool of people using narrowband who want to upgrade to broadband is nearing exhaustion. And the number who see little value in owning and using PCs obviously won't be candidates for narrowband or broadband access.

We rapidly are approaching the point where the "problem" of broadband adoption is no longer a "problem" of access, but a problem of "demand." There just aren't that many more people who want broadband and can't get it. Which means the marketing battler will refocus, as it always does in saturated markets, on upselling more services and features and stealing market share from somebody else.

All things being equal, a facilities-based access platform typically beats a leased-access platform. But there's one more essential ingredient. There have to be customers. In the fixed broadband access market, we are running out of customers.

No Wholesale? No Surprise

To almost nobody's surprise, the 700 MHz auction will not have a mandatory wholesale provision. We might argue that a robust "third" or "fourth" or "fifth" pipe would result. What is harder to argue is that any such pipe provider would be able to make the investments required, operate its network at a high level of quality and still return the required returns to investors.

Other wireless infrastructure initiatives highlight the problem. After reporting a $16.3 million second-quarter loss last week, EarthLink reiterated that it was reassessing its municipal wireless business. Revenue is the issue.

"Until we're confident that we can build new networks and get an acceptable return, we will delay any further new buildouts," CEO Rolla Huff said.

EarthLink has been one of the biggest builders of city wireless networks, with projects built or in the works in 13 municipalities around the U.S., according to its Web site.

The problem with wholesale access business models is simply that it is so difficult to earn an adequate return. In a competitive market, a provider needs both significant penetration and reasonable margin (40 percent is a common threshold). Wholesale makes that tough.

EarthLink, Helio, Muni WiFi

Given that Earthlink essentially admits it now is more than a bit unfocused, and that something has to be done about it, it is pretty easy to predict that Helio and the municipal WiFi initiatives have to go. Earthlink will keep dial-up as a cash cow. It does just fine in the Digital Subscriber Line business and VoIP is not bleeding either. That pretty much leaves losses at Helio, which doesn't appear poised to make major subscriber gains any time soon, or the municipal WiFi business, which is in roughly the same position.

And one has to assume Earthlink will ultimately be set up for a sale. In such scenarios, long-term investments that drain cash are a no-no.

Something has to go. EarthLink now expects a loss of $110 million to $140 million for the year on revenue of $1.23 billion to $1.24 billion. Back out municipal WiFi and Helio losses and that problem takes care of itself.

Earthlink had a second-quarter loss, due to mounting losses at its Helio wireless joint venture and lower revenue from dial-up services. Earthlink says its Helio cellphone business exceeded the 100,000 subscriber milestone in the quarter, but the unit's losses mounted. Helio, a joint venture with South Koreas' SK Telecom, posted a loss of $83.8 million on revenue of $33.2 million.

Earthlink had a loss of $16.3 million, or 13 cents a share, compared with a profit of $16.6 million, or 12 cents, a year earlier. Earthlink said revenue for the quarter fell 6% to $312.2 million from $332.1 million a year ago.

Sure, there were continued losses in the dial-up area, but that's expected. At the end of June, the company had 4.3 million dial-up and broadband subscribers, down from 5.3 million a year ago.

Earthlink is a profitable Internet access company if the wireless and muni WiFi iniatives are abandoned. If you assume the assets are positioned for ultimate sale, that's a clean story.