EarthLink's Big Bet on Broadband

Will building municipal Wi-Fi networks pull the company out of its dial-up doldrums?

New Orleans wants to build a network for high-speed wireless Internet access. And like a growing number of big cities across the country, it turned to EarthLink (ELNK). On May 26, EarthLink said it won the contract to build a wireless fidelity, or Wi-Fi, network that allows low-cost Web surfing across a wide swath of the Big Easy.

Another sign of the big bet EarthLink is making on Wi-Fi, the contract follows the announcement that EarthLink will bring Wi-Fi to San Francisco and other large cities.


 It's a good thing cities want Wi-Fi. Because Earthlink's main business -- providing dial-up Internet access -- is shrinking as consumers opt for high-speed broadband connections. From late 2004 and late 2005, the percentage of U.S. households using slower dial-up connections dropped from 56% to 41%, according to Forrester Research. In the first quarter of 2006 alone, EarthLink lost 179,000 of its 2.28 million premium narrowband subscribers.

EarthLink does resell broadband Internet access from telecom and cable companies, but it has to charge a $5 to $10 premium to make a profit, says Forrester analyst Maribel Lopez. That's a tough sell for consumers who can get feature-packed broadband straight from their existing phone company.

So, like other Internet service providers, EarthLink needs to find other ways to grow. AOL (TWX) is building new features and adding content (see BW Online, 5/04/06, "The Ails of AOL"). United Online (UNTD) is trying to stick it out with super-low-cost dial-up access offerings.


  EarthLink is betting on Wi-Fi broadband service to recapture at least some of those departing dial-up customers and, it hopes, lure new business. If it plays its cards right -- and municipal Wi-Fi takes off -- EarthLink could become a formidable rival to current telcos and cable giants.

An estimated 200 cities in the U.S., and many more abroad, are now considering building municipal Wi-Fi networks, and in five years more than 20% of Internet users might be using public Wi-Fi, reckons Craig Mathias, founder of wireless consultancy Farpoint Group. Many people will simply use the networks for free, checking local businesses' Web sites or surfing the Net while viewing ads.

EarthLink's hope is that a good portion of those users will pay $21 a month or so for premium Wi-Fi service, letting subscribers download data at speeds of about 1 megabit per second, faster than the free service, and roughly 20 times faster than a typical dial-up connection. That's about as much as consumers pay for dial-up access or digital subscriber line (DSL) service.


  There's a big pool of potential customers. Some 40 million U.S. customers still have dial-up and are looking for a cheaper broadband option. A few entrenched players, such as AT&T (T), are dabbling in public Wi-Fi. But EarthLink is emerging as the most aggressive pursuer of the municipal market. "EarthLink is at the forefront of it," says Mathias.

In theory, EarthLink's service could compete with similar offerings from existing broadband service providers such as Comcast (CMCSA), Verizon (VZ), and AT&T. EarthLink's premium service would be a bit slower than DSL, but at $21 a month, it's about half of what some cable companies charge for high-speed Internet access. Wi-Fi broadband could emerge as the third broadband alternative, in addition to DSL and cable.

EarthLink is throwing a lot of its weight behind Wi-Fi. The outfit formed a special municipal network division last October and has increased the division's staff from 35 to 65 people. It expects to surpass 100 employees by yearend.

By that point, EarthLink hopes to have won at least 10 large municipal Wi-Fi contracts, says Donald Berryman, executive vice-president and president of the municipal networks business. And it will bid for some 30 to 40 contracts expected to come up for grabs in 2007.


  EarthLink has already teamed with Google (GOOG) on the Wi-Fi network in San Francisco. Berryman leaves open the prospect that his company may before long join forces with Google on one of the other contracts up for bid. Analysts expect EarthLink to be a frontrunner in the bidding to construct Chicago's Wi-Fi network. The city put out a request for proposals on May 30.

With the number of its networks expected to rise, EarthLink is also pursuing agreements to sell minutes on its networks to other ISPs. It's in talks with four nationwide ISPs and expects to announce partners in the next two weeks, Berryman says.

In the next one to two months, EarthLink also will unveil a Wi-Fi franchising program -- likely the first of its kind. That would help smaller ISPs to establish their own Wi-Fi networks in smaller cities. The franchisees will be able to take advantage of EarthLink's greater buying power and its expertise in rolling out municipal networks in cities like Philadelphia. This program, called the Network Alliance, could vastly expand EarthLink's reach.


  The best part is EarthLink can get that reach at fairly little cost. Wi-Fi networks are cheap to build, costing between $25,000 and $100,000 per square mile. The company will spend some $50 million on constructing the networks this year. "If successful, I can see [this amount] doubling in the next couple of years," Berryman says.

The payoff could be significant. EarthLink's internal research indicates that the network build-out will start generating return on investment within two years. In Philadelphia, whose 135-square-mile network will be completed next spring, the company expects to have 50,000 to 80,000 paying Wi-Fi subscribers by mid-2007, says Berryman. That's no small sum. By comparison, EarthLink added some 85,000 broadband and voice subscribers in the latest quarter. And EarthLink estimates that as many as 600,000 households in Philadelphia might be interested in using its service, either for free or for a daily or monthly fee.

Meanwhile, in New Orleans EarthLink is counting on network use by more than 100,000 workers from government agencies who are cleaning up and rebuilding the city after last year's devastating Hurricane Katrina. EarthLink hopes to enable Wi-Fi access, at 300 kilobits per second or more, within 15 square miles covering areas such as the French Quarter, by Sept. 1.


  Besides direct access, EarthLink might also be able to generate revenue through applications like Web-calling services, advertising, and e-commerce, and enabling automated meter readings.

Analysts say it's a worthwhile effort for a company that has struggled to grow. EarthLink believes the municipal Wi-Fi networks business, expected to start contributing revenues later this year, could add up to 25% to 30% of sales in three to four years, says Berryman. And the margins could be fatter than with its existing broadband service. "[Municipal Wi-Fi] could be a very good direction for them," says Keith Dalrymple, an analyst with New York Global Securities.

More important, because EarthLink will own the networks, "it gives us much more control over our own destiny," Berryman says.

But EarthLink is dealing with some big broadband ifs. "They just have to do a lot quickly, and to execute well," says Lopez. "The issue is, can they structure their business in a way that they can be profitable while they ramp those other businesses?"


  What's more, there's still a lot of uncertainty over just how much demand there will be for municipal Wi-Fi services. Residents of some cities that have already implemented Wi-Fi complain of poor reception; the signal doesn't penetrate some buildings' walls. Coverage can be spotty (see BW Online, 5/02/06, "Wi-Fi Revolution? Not So Fast!") "You may be in a large city 5 to 10 years from now and not have coverage everywhere," says Frank Hanzlik, managing director of industry consortium Wi-Fi Alliance, which certifies Wi-Fi gadgets. And that's not what many prospective users expect.

EarthLink certainly thinks it's up to the task. With $352.8 million in cash and marketable securities at the end of the first quarter, "we have plenty of money to build these [networks]," says a company spokesperson. And with its bread-and-butter dial-up business ailing, EarthLink may have no choice but to make this risky bet now -- hoping that rewards will come later.

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