This dinosaur won’t die: The old dial-up Internet industry is turning out to have a longer life than many expected.
“If we bought into the naysayers, the dial-up business should have ended in 2005. Since that time, we made $300 million” in earnings, said Mark Goldston, chief executive of United Online Inc. of Woodland Hills. “We were supposed to be dead.”
While wireless access seems ubiquitous in cities and high-speed Internet taken for granted in corporate environments, there are huge pockets of the country that still rely on a dial tone before connecting. In fact, about half of the country’s households don’t have a broadband connection.
More than 15 million still subscribe to a dial-up Internet service. These are mostly rural or low-income families whose homes are too far from a DSL tower or can’t afford high-speed access.
These customers support a lucrative, profitable industry that doesn’t seem to want to go away. And companies such as United Online are taking the money they make on the old technology to invest in new businesses some successfully and others less so.
Drawing on what Goldston described as a “magnificent cash machine,” United Online, which had $513 million in revenues last year, has been able to branch out to the social networking and online advertising business with its Classmates Media division. The company last quarter reported a record $40 million in earnings before interest, taxes, depreciation and amortization known as EBITDA, a measure of cash flow from operations.
Earthlink Inc., a competitor nearly double its size in revenue, brought in $52 million in EBITDA during the same period. The Atlanta company has also tried new businesses, investing $200 million in L.A.’s high-tech cell phone company Helio and dabbling in municipal Wi-Fi, only to pull back to concentrate solely on its dial-up operations.
“United Online has done a good job in taking cash flow from the access business and reinvesting it in ad-driven models, as opposed to Earthlink, which spent over $200 million on failed initiatives,” said analyst Youssef Squali of Jefferies & Co.
Yet Wall Street has largely ignored United Online, even though the return to shareholders has been 1,245 percent since the company’s predecessor NetZero merged with Juno and began trading on Nasdaq seven years ago. The Nasdaq composite Index since then yielded 77 percent. Only three Wall Street analysts cover United Online compared with a dozen covering Earthlink.
Consolidation ahead
While its dial-up business remains lucrative, United Online is far from No. 1 in the slowly shrinking sector.
It has 2 million dial-up subscribers, close to Earthlink’s 2.6 million.
AOL has the most, with 9.3 million subscribers, down from 13 million last year. Its dial-up operation got dumped by its parent company this month, when Time Warner split AOL’s dial-up business from its content side, making it an attractive acquisition candidate. In its heyday in 2002, AOL’s dial-up service served 26.7 million.
“There’s a scenario that we will be competing in a dial-up market with far fewer competitors,” Goldston said.
B. Riley & Co. estimates that broadband penetration will reach 95 percent of U.S. households in five years, and dial-up subscribers will dwindle to about 4 million subscribers.
“Dial-up providers would have reached a point where they’re not looking to add subscribers or spend money on sales or marketing,” said analyst Ali Mogharabi of B. Riley. “It would simply generate cash every single month.”
This could happen sooner rather than later as broadband gets cheaper. AT & T;, for example, offers high-speed Internet at $10 a month for new subscribers.
“We’re seeing a tremendous migration of people getting faster speeds at a lower price,” said Deborah Lieberman, spokeswoman for AT & T.; “What we’re hearing from customers is that the more they’re exposed to the Internet, the faster speeds they want.”
Meanwhile, United Online is counting on customers who don’t have a choice: households in small towns and agricultural areas such as Rantoul, Ill., or Bessemer, Ala., that are nowhere near a DSL tower. And building a DSL station for a low number of households doesn’t make economic sense.
Goldston believes this part of America will stay on dial-up for some time. “We still have landline phones and not everyone has e-mail or cable,” he said. “Major habits die a very slow death, if they die at all.”
To reach this customer base, United Online runs national advertising featuring Goldston, who likens his company to Wal-Mart.
“We have mass appeal and that’s O.K.,” he said. “Great corporate fortunes in America were made in Bic pens and Zippo lighters, not Montblanc pens and Dunhill lighters.”
In a business where everyone is losing customers, the company’s efforts to stem the damage seem to be working. The company lost roughly 100,000 accounts during the previous quarter, the smallest number of account cancellations in seven quarters. It also reported 69 layoffs in its dial-up operations, for a savings of $3 million.
Networking works
In the meantime, United Online is establishing itself as a leader in paid social networking through Classmates.com.
In an Internet world where free social networking sites such as MySpace and Facebook rule, paying to get reconnected with friends doesn’t seem to make sense to analysts.
“There is skepticism out there, even though Classmates has proven them wrong with a revenue-generating model,” Mogharabi said. “Some people ask, ‘Why would people pay the monthly fees when you can consider MySpace or Facebook as a substitute?'”
Every time Goldston gets that question, he points to the numbers. Since United Online bought Classmates.com in 2004 for $100 million, paid subscriptions have nearly tripled. It now has 3.2 million subscribers who pay $3.26 a month for premium service.
Visitors to the Classmates site can view any of the 50 million total profiles. Only paid members can send messages or respond to them.
A popular use for the paid service is to plan for reunions. Confirming attendance to certain events requires signing up for a paid account.
As a result, Mogharabi thinks that people might sign up for paid service, but then drop it.
“They’re willing to pay for at least a few months for a reunion or getting back in touch with people who went to their same school,” he said. “But users on Classmates don’t stay for too long.”
Squali of Jefferies & Co. doesn’t see Classmates.com as a true Web 2.0 social networking site.
“People come to pay $3 and quickly churn out,” he said. “They’re not building a community online.”
Also, Classmates.com serves a much older crowd than their free counterparts. More than 85 percent of its users are 35 years old, and they’re mostly women.
The company acquired its other media business, MyPoints, in 2006. MyPoints, a consumer products promotion site, also serves the same demographic. Together, the sites see about 58 million in visitors and generate about 40 percent of the parent company’s revenue.
Last year, United Online tried to take public both businesses under Classmates Media Corp., but cancelled the IPO around the time the market began taking a downturn.
“That’s when the first write-offs of the subprime loans came and people said it was going to be a bloodbath,” Goldston said.
The only way to satisfy the market at that point was to offer shares at a discounted price, and that would’ve defeated the goal of unlocking value of the only growing segment of its operations.
The company was also in no hurry to spin off Classmates Media. It already had $220 million in cash, thanks to its lucrative dial-up business.
Last quarter, the company began reporting earnings on Classmates Media as if it were a separate company. That allows investors who may be interested in Classmates as a public company to see details of its performance. The parent company is planning a new effort to take Classmates Media public in the near future, and make other similar media acquisitions.
