Helio Fools

At the time that I'm writing this post and more specifically this sentence, the S&P 500 is down 2.35% (per Yahoo! Finance with 15 minute delay). One of the few companies which had gone up in stock value is a once lovable little broadband high speed internet provider, Earthlink (ELNK) which is up approximately 7.14%.

The big news with ELNK is that the firm is closing 4 of its offices and cutting about 900 staffers, roughly half of its work force. The market is seeing this as a positive news item and signs that the firm will save about $30 this year with additional savings in the future. This couple with the annoucement that the firm will spend about $200 million to buy back shares are driving up the stock price on this otherwise dismal day in the market.

Here is my take on the loving the market is giving to ELNK:

The fools who invested in this company today are most likely going to lose their money. Although savings will come from cutting 900 staffers, this is actually have a negative affect on the firm. With the loss of half of its staff, how will this company operate efficiently. Customer service will suffer and people will be drive to other internet service providers such as their local cable companies and AOL. Additionally, how will the company have enough resources to re-focus on their core strategy (if they ever decide to back out of Helio). In saving approximately $30 million for the next 4 months, ELNK will take a $65M hit, leaving a net loss of $35M from the staff cut. Would future savings be enough to cover current year's loss and customer service?

Now let's take a look at their cash flow situation. Adding back D&A and net working capital, I've come to $33.161M in Net Operating Cash Flow. Subtracting out ELNK's capital expenditures (because it has to spend money to make money) of $23.879M, its FCF is a $9.282M. This is all kosher until you take into account that approximately $11M of this FCF is due to stock base compensation. I don't know about you but I certainly do not want my company to make money from stock options. As such its True FCF which backs out the stock compensation component is a negative $1.5M. With negative cash flow for the first 6 months of the year, how will the firm come up with the necessary funds to buy back $200M worth of stock. The answer would be to borrow the money but in this credit crunch environment rates will definitely be unfavorable. If ELNK was annoucing the funding of stock purchases 2 years ago I would applaud but in today's environment, I am definitely cringing at the thought of paying high interest rates.

In it's agreement with Helio, ELNK has already signed up to extend to them an additional $100M of working capital of which $30M has already been commitmented (as stated in the 2Q07 10-Q) in July. Although the new CEO promised to review all of ELNK's current strategies it is obvious that he is not looking at it thoroughly enough. Why else would he waste more money on a losing venture? Even though ELNK will be receiving a 10% interest on its loan, would Helio survive in business long enough to pay the interest + principal? Additionally, why is the CEO telling the public that ELNK will re-focus on its core strategy of being an ISP when it is making such large commitments to a losing venture that it will plan to shed? Hmmm......

There are just too many questions on about this company. The CEO is currently not performing up to standard on his due diligence. Although I fall short of buying put options on this ELNK, the operations of the the firm is in dire straits. The only positive is that the CEO may put the company back on its original business which would boost the company back to positive cash flow territory. Even if he does this though, how much would the firm be able to grow in this tougher competitive environment where its customer service will lag those of its peers.

For those who ELNK today, I suggest to you to sell now and take small loss rather than losing the entire ship in the coming quarters.