For EarthLink, a Silver Lining in AOL-Time Warner Merger

ATLANTA — Mike Lunsford got the news about 12:25 p.m., just as he was stepping onto the sidewalk in front of EarthLink Inc.’s headquarters here to cross the street. A colleague called on his cell phone and told him, “It’s over!”--federal antitrust regulators had finally voted to approve America Online Inc.’s $183-billion takeover of Time Warner Inc.

Lunsford wasn’t sure whether to be happy, afraid, or both. He settled for being relieved.

Last month, Lunsford helped EarthLink snag a prized piece of digital real estate by negotiating a carriage deal with Time Warner, a potentially lucrative contract that would become active only if AOL’s merger with Time Warner closed. FTC officials had told AOL that they would block its takeover of Time Warner without such a contract.

Helping strengthen chief rival AOL--already six times its size in terms of subscribers and eight times its size in revenue--isn’t exactly characteristic of EarthLink, a venture that in many ways remains in aggressive start-up mode despite being the nation’s second-largest Internet service provider, with 4.6 million members. But the deal with Time Warner makes clear that EarthLink is not just any scrappy Internet company anymore. Its fortunes are now entwined with the very guys it was fighting against for its existence.

Unlike some of its competitors, EarthLink began investing in high-speed broadband Internet technology early on and now sees it as key to its long-term success. EarthLink will be the first nonaffiliated company to have the privilege of offering high-speed Internet access through Time Warner’s cable television lines, which reach more than 20 million U.S. homes.

The broadband team Lunsford oversees is one of the largest in the company, with about 275 employees. When the year began, the company had 25,000 broadband customers. It now has about 140,000, who have the option of getting the service through cable modems or digital subscriber lines. A two-way satellite service will roll out in January.

At the same time, the company has launched a $15-million national advertising campaign that President Mike McQuary describes as “a bit of a poke at AOL.”

“It’s centered on the concept that EarthLink is the provider of the ‘real Internet,’ ” he said. “We don’t select content for people or put things like ads in your face.”

In an interview at EarthLink’s offices this month, McQuary and Lunsford offered the most detailed description to date of the company’s cable negotiations with Time Warner, which were hammered out over two weeks and involved such high-level officials as Time Warner President Richard Parsons.

EarthLink will pay Time Warner $25 to $30 per month out of the $40 it charges each customer. It also will give up a double-digit percentage of its advertising, e-commerce and other supplemental revenue such as music subscriptions.

EarthLink will be able to control the first screen that customers see on their monitors and bill customers directly unless the users ask to bundle their statements with their Time Warner cable payments. The company also got stipulations that the cable provider would give it a dedicated portion of pipe, so EarthLink subscribers won’t compete with users of AOL and other ISPs to get onto the system.

The company also was able to get Time Warner to allow EarthLink to connect set-top boxes to the cable lines so it can offer such services as video on demand and, most important in Lunsford’s point of view, Internet telephony.

“That was a very big deal. Imagine plugging your computer into your cable line and you can make calls all over your home through the Internet,” said Lunsford, executive vice president for broadband services. He said EarthLink hopes to eventually offer a service that allows people to make 1,500 or so minutes of calls anywhere in the world for a small monthly fee.

On the other hand, EarthLink couldn’t get Time Warner to agree to embed its services in the cable boxes that residents must have to get basic services. Customers who want EarthLink’s video and telephone services must buy a separate box. That means EarthLink won’t be able to create a channel-surfing guide like the one featured in AOL’s new interactive television product AOLTV. It also couldn’t get Time Warner to share its vast content, such as music videos or music, on the same terms it might give to AOL.

EarthLink executives say they felt those two issues aren’t important to the company’s core business. “Maybe I’m missing the boat, but I really don’t think it’s a big deal,” Lunsford said.

Officials at entertainment ventures such as Walt Disney Co. and more diversified companies such as Microsoft Corp., however, argued to federal officials that nondiscrimination conditions for set-top boxes and interactive television are essential.

Given that the FTC probably will hold up the EarthLink contract as a model of an open-access agreement, the deal also has been criticized by smaller Internet service providers as insufficient.

Joseph Jay Marion, executive director of the Florida Internet Service Providers Assn., believes that EarthLink sold out the industry and that it’ll run into problems because it conceded too much.

“EarthLink is a company that is having some financial difficulties. We believe AOL Time Warner threw them a life preserver. But the problem is there’s a tidal wave coming from behind,” he said.

Marion said the FTC decision will force a lot of mom-and-pop ISPs out of business because they won’t have access to high-speed cable lines.

EarthLink President McQuary said the company “at no time” gave the impression it was negotiating on behalf of anyone other than EarthLink. He agrees many smaller ISPs will go out of business, “but the cause of death isn’t going to be lack of open access. It is poor business models in general.”

But Wall Street analysts are beginning to question EarthLink’s business model too. Salomon Smith Barney’s Lanny Baker said the next few months will be a “challenge” for EarthLink as it dips into its cash reserve to build out its broadband infrastructure--with little advertising revenue to back it up.

“AOL’s business model is a heck of a lot more productive than EarthLink’s,” he said, “although EarthLink looks like they are within spitting distance of making money with their strategy.”

Meanwhile, Lunsford said he is confident that EarthLink will be able to differentiate itself from AOL because of its appeal to free thinkers and rebels who don’t want to have to go through the “walled garden” of preselected content that AOL offers for customers’ convenience.

“AOL’s selling a Ford Taurus. It’s a great car, very comfortable, but not everybody wants a Ford Taurus,” he said. “Our customers are the ones who want Volkswagen Beetles.”