United Online Rewarded as Market Favors Pay Service

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United Online Rewarded as Market Favors Pay Service

Corporate Focus

by Anthony Palazzo

Back in September, when NetZero Inc. completed its merger with Juno Online Services to become United Online Inc., few gave the Westlake Village-based provider of free Internet service much chance of surviving.

Other providers of online freebies like computers and advice had already bitten the dust. In the post-Internet boom environment, investors were demanding dot-coms make money, just like everybody else and this one had lost more than $200 million in its previous four quarters.

NetZero’s stock was trading at $1.84 a share that day, down from an adjusted close of more than $177 in January 2000, and the company had no following on Wall Street. The merger was seen as a desperation move by two dying, concept-driven companies.

But a funny thing happened on the way to the morgue.

United Online’s management woke up, figured out how to transform their ad-dependent business to a revenue-bearing subscription model, and put their new plan to work.

To nearly everyone’s surprise, the stock has zoomed, to more than $12 a share recently. United Online last week posted first quarter results that showed positive cash flow and an operating profit (although non-cash charges drove it to a final loss). “To our credit, we were adaptive,” said United Online’s triumphant chief executive, Mark Goldston. “People thought this was a fool’s errand three years ago.”

Just in time

In fact, NetZero’s original plan was flawed, but its management transformed its strategy in time to save the business.

In its first incarnation, NetZero relied on advertising revenue to support free Internet access for millions of customers. The new plan, which became necessary when the advertising market imploded at the beginning of 2001, was to use free access as a way to drive users toward paying $9.95 for Internet service.

Goldston insists the old plan would ultimately have worked had the advertising market remained healthy. “Unfortunately, it didn’t,” he said.

While the cost of providing the service declined as telecom costs fell, they “could never fall fast enough for you to catch up with the decline in the ad market,” Goldston said.

Last year, NetZero began offering discount Internet service for $9.95 a month as an add-on to its free service. As the ad market failed to improve, the paid service became its focus.

NetZero limited free access time and took other measures to wean users off that service. It endured jokes about its pledge never to charge for Internet access. It began taking in more revenues.

“We kind of paid attention,” said Peter DeCaprio, a principal with Thomas Weisel Partners who’s been covering the telecom services market for 10 years. “The economics of the business were improving.”

Integrated success

A big part of United Online’s success has been its ability to swiftly integrate NetZero and Juno. By the time the new company was formed, it was already well along on an integration plan that managers at NetZero and Juno had been working on for five months.

Starting this work early was risky, said Goldston, who led NetZero before the merger. “If the merger didn’t close, you’re doing all this integration work that would not come to fruition.” But it did, and the new company immediately began putting its new strategy to work.

In January, United Online reported a 14 percent sequential rise in revenues for the second quarter ended Dec. 31. It also projected positive pro forma Ebitda by June, two quarters earlier than it previously forecast. (Pro forma Ebitda represents profit or loss before interest, taxes, depreciation, amortization, restructuring and merger-related charges, and other income. The pro forma figures don’t match generally accepted accounting principles, but United Online said it believes the figures are an “additional meaningful measure of operating performance.”)

United Online outsources its customer service and billing for its 1.6 million paying accounts (there are 5.2 million active users, including unpaid). It has 430 employees, compared with about 6,300 at EarthLink managing 4.2 million accounts.

United Online’s software is lightweight enough to be downloaded off the Internet, saving it the expense of sending out disks a la EarthLink and AOL. As a result, it pulls in twice the revenue per employee that EarthLink does, easing its path toward profitability, according to Goldston. “We’re like a virtual company,” he said.

Last week, United Online posted results for its third quarter ended March 31, showing it made additional progress toward profits. Pro forma Ebitda was a positive $4.5 million, beating its most recent estimate by another three months. In its final figures, the company reported a loss of $7.3 million, or 19 cents a diluted share, compared with a loss of $15.7 million, or 41 cents a diluted share, in the December quarter. Revenue rose sequentially to $50.9 million from $48 million.

Ultimately, said DeCaprio, one of its higher-cost competitors may have to buy United Online if prices for dial-up online service come down far enough. He doesn’t see that happening, though, for at least a year, until falling broadband rates force dial-up rates downward.

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at

[email protected].

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