Fire sale at PSINet

ISP prepares to divest consulting units How does a top 10 ISP, whose name adorns the Baltimore Ravens' football stadium, wind up gasping for air on the stock market and readying a sale of assets to fund ongoing operations? That's a question stockholders and followers of PSINet asked last week as the self-proclaimed "Internet supercarrier" enlisted Goldman Sachs to help it weigh various options for divesting chunks of itself.

By most accounts, PSINet's troubles started when the company began acquiring consulting businesses such as IT solutions provider Metamor Worldwide in March 2000 to bolster its Internet service offerings. Although PSINet had integrated most of its myriad ISP acquisitions deftly, Metamor and other deals proved to be more tricky, according to analysts. At the same time, the company seemed to take its eye off the core access and hosting businesses, said Dan Renouard, analyst for Robert W. Baird & Co.

"The Metamor acquisition was clearly a big mistake, but I also think management's ineptitude was another contributing factor," Renouard said.

PSINet repeatedly lowered earnings estimates and, in some cases, failed to meet the reduced numbers. Then the company's top financial executives left, and PSINet hired a chief financial officer with no experience in communications. "They made their own bed by not focusing on execution," Renouard said. Although recent troubles in the free ISP business may contribute to the acceleration of PSINet's demise, they did not cause it, he added.

David Takata, senior vice president of Gerard Klauer Mattison & Co., agreed. "Their core competence was in networking," he said. "They knew how to acquire ISPs. When they acquired [Transaction Network Services] and Metamor, those were more difficult integrations."

These consulting operations are the assets most likely to be sold off to raise cash so that PSINet can avoid bankruptcy. An outright acquisition of PSINet is possible, as many service providers might want to get their hands on the company's 12 hosting centers and other network properties. But it's not likely, given that PSINet holds $3.43 billion in long-term debt that the buyer would have to assume and only about $2.25 billion in "hard" assets, Renouard said.

"The value of the company's assets is a moving target, to say the least," Renouard said. "We know the assets aren't worth what they say on the books."

PSINet already plans to dispose of its 80% interest in Xpedior, an Internet consulting firm acquired as part of the $1.9 billion Metamor Worldwide acquisition. Credit Suisse First Boston will manage the sale. But the damage already has been done - during the third quarter, the downturn in Internet consulting stocks forced PSINet to write down the Metamor and Xpedior assets to the tune of more than $1 billion. Then, PSINet had to inject $15 million into Xpedior to keep it running until it can sell its stake, which it expects to do by March 31, 2001.

The other asset likely to be sold is Inter.net, a cash-hungry global consumer ISP business that serves 550,000 customers in 13 countries. For the third quarter, Inter.net contributed about 7% of total revenues, $23.6 million, but generated 11% of the company's cash flow losses, or negative EBITDA.

"They're going to try to sell whatever they can sell," Renouard said. "The question is, when they get done selling, is there going to be anything left for the equity holders?"

As of Sept. 30, PSINet had about $1 billion of cash, cash equivalents, short-term investments and marketable securities, according to the company's 10-Q report filed with the Securities and Exchange Commission. But $133 million of that is restricted cash, which can only be used to pay down debt. The company burned through about $1.3 billion during the first nine months of 2000 - a rate of about $400 million per quarter. That suggests the company has only about two quarters to close some deals, Renouard said.

"My guess is [Chairman and CEO William] Schrader won't let the company go bankrupt - he has a big investment personally," Takata said. "They will try to get it down to their core networking business."

To conserve cash, PSINet plans to scale back capital expenditures on hosting center construction by $100 million to $200 million. It also is trying to reduce commitments requiring cash payments. The company already shed 104 employees - incurring a restructuring charge of $22.2 million in the third quarter - and may struggle to retain top talent.

On Nov. 6, the board of directors approved a grant of about 20 million shares of common stock to almost all PSINet employees "for retention purposes," according to the company's 10-Q filing. With PSINet stock trading at a dollar and change, "most people's options are deeply underwater," said a PSINet spokesman.