Internet Service Provider Earthlink (ELNK) hit new 52 week lows today. After writing about AOL last week, I noticed that many of the same gurus who bought AOL in the second half of last year also bought into Earthlink at around the same time. It appears that these investors have a thesis that reports of the death of the dial-up business may be overblown. Even if that’s the case, Earthlink is a different animal than AOL. Let’s look a bit deeper.
For those of you who came of age in the past ten years, you may not remember how in the mid to late 1990’s your house’s phone line doubled as your internet access point. It was always a great time when someone called when you were in the middle of downloading a file, kicking you offline. Of course trying to open a page at 14.4k meant that it would take you all afternoon to read a website like GuruFocus. At any rate, this was Earthlink’s domain. They’ve begun to reallocate the money from their still existing dial-up service to some other, more modern, ventures.
Earthlink operates in two segments: Consumer Services and Business Services. Their consumer division still does that dial-up stuff. In the business area, Earthlink has been an acquirer. They recently completed the acquisition of STS Telecom, which caters to small businesses in Georgia and Florida, and expect it to add more than $15 million in revenue in 2011. This isn’t bad considering they had $167 million in revenue in the last quarter. They also acquired two companies: ITC DeltaCom and One Communications last year at reasonable valuations. These businesses will help Earthlink’s business offerings.
Increased business offerings alone aren’t what are attracting investors to the stock. Their balance sheet is what makes the company attractive. They ended the last quarter with $563 million in cash and investments and no debt. They also generated $195 million of free cash flow last year. With 108 million shares outstanding, you’ve got more than $5 per share of cash. You can also throw in a $0.20 per share annual dividend. 2010 EPS was $0.74 per share. One way to look at this is that you’ve got a PE of about 10. If you back out the cash, however, you’ve got a PE under 4. However, given management’s propensity and desire to make acquisitions, you have to be careful about how you look at their cash hoard. The company has announced 2011 guidance with an EPS around $0.45.
Here’s the interesting thing about Earthlink: Joel Greenblatt, Steven Cohen, and Bruce Kovner made purchases in Q4 2010, and Jeremy Grantham had made a purchase in Q3. This group also had made purchases in AOL in Q4 2010. Additionally, Chuck Royce owns Earthlink and AOL. David Dreman owns the most shares out of the group, though, controlling 3.8% of the outstanding shares.
Those owners seem to have a thesis about the dial-up business, but it’s important to keep in mind that Earthlink and AOL are heading in very different directions, although both of their stocks are hitting new lows. AOL is trying to own content, and Earthlink is trying to transform itself into a business provider. Each is relying on the cash generated by their legacy dial-up business to fund these changes. Because Earthlink’s cash is being spent on acquisitions, it’s important for investors to have a thesis on management and their direction. If that cash is squandered, and those acquisitions don’t work out, then Earthlink will prove to be a value trap. My worry is that investors will only discover after the fact if buying stock in Earthlink is a great deal at this price or not.
Disclosure: No positions