StockTalk

TMF Interview With
OneMain.com Inc. Chairman and CEO Stephen Smith

With Brian Graney (TMF Panic)
September 27, 1999

Based right down the road from Fool HQ in Vienna, Virginia, OneMain.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ONEM)") else Response.Write("(Nasdaq: ONEM)") end if %> is an Internet service provider (ISP) that caters to smaller metropolitan and rural markets often underserved by national Internet access providers. The company, which went public in March, refers to itself as "your hometown Internet." We talked with Chairman and CEO Stephen Smith about OneMain's strategy, what differentiates the company from its rivals, and the future of the ISP business.

TMF: To start off, what are you trying to do at OneMain?

Smith: We're an Internet

"What we're trying to do is sort of be the local Internet newspaper in all of these small markets."

service provider among other things with a very differentiated business model. We have approximately 530,000 subscribers today and they are largely in small markets in America. We focus on all markets that are non-top 25 metropolitan statistical areas (MSAs). What we're trying to do is not only provide high levels of customer service on the access side, but differentiate [ourselves] through the geographic communities that we are setting up in each of the small markets that we serve.

The way OneMain came into being was that we developed a proprietary technology with the folks at MIT. We created a technology that is a server-based system that reads someone's area code or zip code when they log onto our service. Then, that will download a first-up Web page that has very geographically specific, highly granular, localized content in their market.

If I'm in Fort Smith, Arkansas, which is a big market for us where we have about 25,000 or 30,000 users, we would have the hunting and fishing reports, we would have the local weddings, we would have the local police blotter and the local weather in addition to having national news and stock quotes. Again, very highly granular local content that's specific to that market.

So what we're trying to do is sort of be the local Internet newspaper in all of these small markets. And we believe the high-degree utility of the first-up Web page is what's going to distinguish us over the long term. We're essentially setting up small geographic portals throughout the country and using access as the basis through which to aggregate traffic.

If you look at our service quality, which we are maniacally focused on, we have systemwide about an eight-to-one subscriber-to-modem ratio. We are a facilities-based ISP and believe vehemently that being a facilities-based ISP is the way to go, because we own our own network and therefore service quality is in our own hands.

You would very rarely, if ever, get a voicemail on the end of the line when you call in with a customer support or billing or technical support question. It's almost always a live voice and that's one reason that you see that our churn rates are among what we think are the lowest in the industry. Our rate averages 2% to 2.5% monthly versus an industry average of 6% to 10%. If you look at MindSpring <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSPG)") else Response.Write("(Nasdaq: MSPG)") end if %> or EarthLink <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELNK)") else Response.Write("(Nasdaq: ELNK)") end if %> or AOL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>, they run at about 4.5% to 5% monthly.

TMF: Do you think that's really going to be the differentiating factor for ISPs five years from now, the customer service aspect?

Smith: I think it's going to be twofold. It's going to be the customer service aspect because this is really a service-oriented business. Number two, it's going to be providing utility through the first Web page and value-added services that don't have a lot of advertising on them.

If you think about our first-up Web page and divide it up into a grid, each of those pieces of the grid or pieces of real estate are what we call nuggets. If we dynamically link each of those nuggets to a content provider, we're essentially a content aggregator as well as an ISP. In essence, we will do sponsorship arrangements in each of those pieces of community or click-throughs to e-commerce sites so there won't be much advertising. In fact, there won't be any banner advertising on our site.

Just to give you an

"I think the EarthLink/MindSpring merger is very good for the market. What it shows is that scale matters in this business."

example, we have an arrangement with somebody where they're going to aggregate all of the local weddings in each of the local markets so we can print out wedding announcements. The sponsor of that will be one of the e-commerce sites that provides wedding information. You'll just click on a pass-through button on that to get to that site and then we'll share revenues either through a sponsorship arrangement or transaction arrangement.

What we plan on doing is every three months or so, we will go out and survey our subscriber base and ask them how we are doing in terms of local content. When we see where there [are] areas that people want additional local content or more granularity, we'll go out and find the right content because it all exists out there through various sources. These communities will evolve so that subscribers feel like they own the first-up Web page, that that community is theirs and they have some influence. We're responsive to what they want to see. And we think that the future is really going to be about people that provide high value-added services through content and not through advertising.

The number-one reason people leave AOL and join us, for instance, is because they hate pop-up [advertising]. We probably get a good portion of second generation AOL subscribers in our markets. But let me step back a second. Our main competitive advantage is that America Online and the national providers are a long distance phone call in a lot of our markets -- more than 50% of our markets. So [there are] very high toll charges. The free ISPs don't even reach a good portion of our markets. NetZero <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NZRO)") else Response.Write("(Nasdaq: NZRO)") end if %> either has a toll charge or you can't even access it in a good portion of our markets.

That being said, we do have markets where we compete head-on with AOL. We get a lot of refugees from AOL. When we ask people why they left AOL, the number-one reason is because they get tired of the pop-up advertising or they get a lot of busy signals when they dial up on their service.

TMF: How does last week's MindSpring/EarthLink merger change the ISP business? How should investors really interpret that merger?

Smith: I think The EarthLink/MindSpring merger is very good for the market. What it shows is that scale matters in this business. For them to be able to provide more value-added services and have content providers be more interested in them, they had to have more scale.

What differentiates OneMain from either EarthLink or MindSpring -- and one of the reasons I became very interested in the ISP business -- is that ISPs are really ready-made distribution systems for Internet services and products. By definition, ISPs aggregate traffic on the front end. MindSpring and EarthLink are very, very good companies and we look up to them as providers, but they did not do a very good job of leveraging their subscriber bases in terms of content and strategic partnerships on their first-up Web page.

AOL has actually done a pretty good job of leveraging their subscriber base. [But] the issue there is that they have what we call a virtual community, which means it extends to all of their subscribers. No matter where you dial in from, you're placed in a ... large virtual community so when you log on you're anonymous and very transient.

Our networks are all geographically centric so that when you log onto our service, you're very geographically focused. And because of our communities creating these portals in small markets, that has a lot more appeal. The targeted eyeballs are more appealing to content providers or people that want to target specific demographics for e-commerce or even advertising in a specific means. That's why we can be much smaller at 530,000+ subscribers and actually garner more dollars.

You saw this week, or last week, where Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> decided to not decrease pricing, but actually increase pricing by $2 [for Internet access]. It's tough to make money in this business at anything less than $15 or $16 per subscriber per month in subscription fees. The long-term value of subscribers is a [low] churn rate and keeping the subscribers that you have or providing ways you can get nonaccess related revenue. Remember, AOL gets about $5 per subscriber per month in nonaccess-related revenue and that's pure profit to them. We're projecting and guiding the Street to a number that looks like $1 per subscriber per month by the third quarter of the year 2000.

If you look at the free ISP model, this is why free ISPs will never work. They're advertising-based. The reason people sign up for free ISP service is because it's free, but there's a lot of hidden charges related to toll charges that the local phone companies charge. The outsourced networks they use [only] cover about 60%, maybe 70% of the country at most and mostly large metropolitan markets.

I don't care who they are, they're still paying probably $5, $6, maybe $7 per month per subscriber in telecom charges to provision services. The telecom people -- the backbone providers and the people that access the local loop -- aren't giving the service away free. Therefore, the free Internet guys have to be more efficient than AOL in garnering advertising dollars just to break even. And AOL has 19 million subscribers. I just don't see how the model really works.

TMF: As bandwidth

"The free Internet guys have to be more efficient than AOL in garnering advertising dollars just to break even, and AOL has 19 million subscribers. I just don't see how the model really works."

increases and Internet access becomes more prevalent, do you see the ISP business transitioning in the way the telecom business has transitioned to cutthroat pricing? Will that ever happen in the ISP business or is it totally separate from what is happening in the telecom arena?

Smith: I think you saw where pricing is really going to stabilize. If you look at the ISP landscape, you've got AOL as the dominant number-one with roughly 19 million subscribers and they charge $21.95 per month. And then you have Microsoft Network which is number-two with 2.5 million subscribers, roughly, maybe even a little bit more. They're now going to charge $21.95 a month. MindSpring and EarthLink charge roughly that amount -- maybe $19.95 a month.

Telecomm as an asset is really a commodity. What we provide is not only high levels of customer service in a commodity-like environment, we also provide content which we think over the long term is going to be very highly utilitarian for our subscribers. And they're going to want to pay for our services.

TMF: Do you think there's any one aspect of the ISP business that is misunderstood by investors and analysts?

Smith: I think what people don't understand about our business is that the churn rate is really what's very important. Our cost to add an organic subscriber last quarter was about $60 per subscriber. Since our churn rates are so low, we're building scale more cost-effectively than other people that have higher acquisition costs. So, I think that's one of the things. The churn rate is what's really misunderstood about the business. Those that have low churn rates are providing good levels of customer service and that's what people want. That, and a reliable connection when they dial up.

TMF: Well, thank you very much. I appreciate the time you've taken to talk to us.

Related links:
--OneMain.com website
--OneMain.com message board