Market overreaction?

PSINet explores funding options The Internet's self-proclaimed "supercarrier" PSINet is in danger of being grounded. At least that's been the common perception the last few weeks as the company attempted to keep its falling share price afloat amid discussions about its funding problems. But now there are suggestions that the market overreacted to some of PSINet's negative announcements and that the stock could be a bona fide bargain.

"People are starting to get the joke - the share price is below the cash holdings of the corporation," said a PSINet spokesman.

The most recent round of trouble for PSINet, one of the premier Web hosting companies, was triggered by a Sept. 15 announcement: The company lowered revenue guidance for the second half of 2000, attributing the adjustment to anticipated "softness" in the carrier access business, slower-than-anticipated growth in the seasonal transactions solutions business and recent guidance revisions by its consulting division Xpedior, which was feeling the effects of the dot-com consulting downturn.

But perhaps more frightening to investors, PSINet said it required an additional $600 million of funding in 2001 to continue the buildout of its Web hosting centers. Because the company already was $3 billion in debt and its stock price was languishing from March highs, follow-on debt and equity offerings didn't seem like an option. The stock market reacted with a vengeance, dropping the company's shares 19% to $11.75 on that Friday. And the stock continued to slide, falling to an intraday trading low of $4.75 during October before rebounding to a recent price close of $7.56.

But what the market ignored, according to some analysts, was that PSINet has a substantial reserve of non-core assets that it could sell to raise the $600 million. PSINet CEO Bill Schrader has stated that the company is sifting through its assets to find those it could sell in the next three to nine months.

Among PSINet's choices could be to sell a portion of its PSINet Ventures portfolio, which has a total estimated worth between $1 billion and $1.5 billion, according to analysts.

Another likely move would be to spin off or sell the Inter.net global consumer ISP business, a cash-hungry division that serves 600,000 customers in 20 countries and was created from 74 acquisitions made by PSINet over the years. Inter.net produced pro forma revenue of approximately $26 million in the second quarter but contributed about 40% of PSINet's negative EBITDA.

"I think [Inter.net] could be a nice asset for somebody like EarthLink, which would be history repeating itself," said Vik Grover, analyst at Kaufman Bros. "MindSpring bought PSINet's retail division a few years ago, and now EarthLink, owner of MindSpring, could do the same on the global ISP side. That's an obvious deal that could be worth a few hundred million, and if it's not EarthLink, somebody else like AOL could pick it up."

Another alternative for PSINet is to stop constructing hosting centers, Schrader said, adding that the company is ahead of the demand curve. By end of next year, PSINet plans to have built 18 data centers - on average each will have 70,000 to 100,000 square feet of hosting space. Ten of the company's planned data centers are completed, including a recent opening in Amsterdam and a planned November opening in Dallas.

"They don't necessarily need the capital - one alternative is to not grow as fast,"said Dan Renouard, analyst at Robert W. Baird & Co.

The other "positive" element in the Sept. 15 announcement was that new Chief Financial Officer Larry Hyatt reined in revenue and cash flow estimates in hopes of setting more realistic financial targets, Grover said. PSINet has had trouble in the past meeting the financial metrics it establishes and, as a result, analysts have been skeptical of projected numbers. In addition, the company lost its top three financial executives earlier this year and took a long time to replace them.

"The problem is that this management team hasn't demonstrated any fiscal responsibility to date, and now that's reflected in the stock price," Renouard said.

But if PSINet can get its financial house in order and ride out its short-term capital constraints, it could be one of the long-term survivors in the Web hosting and consulting space. The business model for its data centers alone causes analysts to salivate. According to PSINet, by the end of the fourth year of operation (2005 or thereabouts), each data center will produce just under $200 million in revenue, 81% gross margins, $120 million in EBITDA and $105 million in free cash flow.

"A combination of outperforming expectations on the revenue and cash flow side, selling non-core assets such as the consumer ISP [Inter.net] or some telecom assets and monetizing the venture portfolio means there is zero funding gap," Grover said. "I think the stock is a screaming buy and couldn't disagree more with my peers."