SK Telecom & Earthlink
"You'll never see it here."
Ahhh, that's the all too often missive given after excitedly reviewing the latest spectacular array of features on the very best and most innovative cell phones available on the planet. Where are those phones usually released? South Korea. Who releases them? SK Telecom. Well, the WSJ is reporting today that Earthlink and SK Telecom are hooking up to bring a new wireless virtual network (actual network infrastructure rented from other players) in the US, on the backbone provided Verizon and Sprint Nextel (starting with the latter). They are putting in $440M and hope to have 3M customers by 2009 generating $2B in revenue, focusing on high-end data services.
Is this a reasonable business venture?
The Story: High end phone lust is palpable in the US, and frustrated by current carriers adoption policies. The RAZR is a lone standout, and has sold like crazy. But while it is very pretty, it's pretty average in terms of what is easily available in South Korea. So market demand is likely strong here. However, the slow adoption rates for new phones here is not due to a lack of phone technology, but rather to the conservative practices of the network owners, who do extensive testing on any possible phone offering to insure that it plays nicely with their network. Will that extensive testing (sometimes delaying the release of a phone for 2 years) be relaxed for the new virtual network operator? On the one hand, if the phones are crap, it will not reflect on Verizon or Sprint, but rather on Earthlink and SK Telecom, so the former may not mind taking the chance. On the other hand, if the phones are security risks or otherwise are problematical on the network, that will affect Verizon and Sprint, so they will worry about that. That the deal has moved to the funding stage means that that latter concern has been addressed. This part of the story is good.
On the other hand, the competitive moat this deal will have is the fancy phones. If the deal turns out to be a very good one, the network owners, who also offer their own services, could just adopt those same phones themselves, and EarthLink's advantage evaporates. Even if there are exclusivity agreements to try to stymie that, new phone innovation is quick enough that novel products would nonetheless become available. This part of the story is not so good.
The Company: The way to play this in the US is through Earthlink (ELNK). Both Sprint and Verizon have some nice things going on for them right now, but the specific issue here is the high end fancy phone market, and that is better played specifically through this deal. The deal is figuring about $55/month/subscriber, which is reasonable. The subscriber targets are also reasonable, given that Boost Mobile, one of the better players in the low end market with a similar structural model, garnered 1.7M customers in ca. 2 years. I don't know the details of the revenue sharing for the deal, but Earthlink had trailing 12 month rev of $1.31B and 12 month operating income of $165M, for a 12% operating margin. Verizon wireless has a 21% margin, and Cingular's is 31%, so this wireless deal is likely to be accretive for Earthlink. How much so is an unknown, as SK Telecom will take a big cut, as will Sprint and Verizon. If each takes a quarter, that leaves $500M for Earthlink, and lets guess 20% margin for $100M earnings in 2009. That would be a major addition to their current earnings, and annualized over 4 years would alone give an earnings growth rate of 12.6%, compared to their latest quarterly trailing Y/Y growth rate of ~16%. Given the wide margins of error on the estimates used here, and that I have tried to lowball numbers, the estimate is neither compelling nor uncompelling.
The Stock: ELNK moved up in 2003 from 5 to 10, but has been in a tight trading range since then, despite a trailing P/E or around 10. Will this deal get it out of that range? Unlikely given the numbers above and the extended time frame, although when the first products hit here there could be some buzz.
Conclusion: We should all thank SK Telecom for, hopefully, bringing some greater excitement to the US wireless handset market. But the deal so far doesn't seem particularly compelling, unless, as it develops, the numbers exceed their targets. Follow it on that basis.