TruthSeeker reports on DSLN
"All the Glitters isn't DSL Gold"
THE TRUTHSEEKER REPORT
thetruthseeker.com
DSL.Net (DSLN)
545 Long Wharf Drive
New Haven,CT 06511
203-772-1000
DSL.Net is a provider of DSL services in second and third tier markets. DSL.Net does not manufacture DSL equipment, it merely provides data services using DSL technology.
A Troubled IPO:
In early October 1999, Alex Brown and DLJ took a tiny New Haven-based company public. The company raised $54 million, selling 7.2 million shares. Sadly, this was reduced from what the company had expected to raise only days before. The plan at the beginning of October was to sell 9.6 million shares at $8 to $10.
Alas, this was not the only time the deal had been cut back. The company originally filed to go public with DLJ as lead manager in early June 1999, seeking to raise $115 million. The company said it needed the capital to fund
its expansion.
On August 4, 1999, the company said it would delay its offering, due to "market conditions". When the offering reappeared at the end of September, however, the size had been reduced to 9.6 million shares with a range of $10
to $12, and DLJ was no longer the lead banker. This is unusual.
Deal with Microsoft:
On August 10, 1999, shortly after shelving their IPO plans, DSLN made a pact with Microsoft. Microsoft purchased 2.029 million shares of stock for $15 million, a price of roughly $7.40 per share. Investors should not get carried
away by this investment, however, as Microsoft has made significantly larger investments in DSLN's competitors COVD RTHM, and NPNT. Microsoft has made a $30 million investment in NPNT and $30 million in RTHM, for example.
Deal With Staples:
DSLN has also entered into a deal with Staples, whereby Staples bought 360,000 shares at $7.23 per share. In return, DSLN will be Staples' "exclusive supplier" of DSL services in markets served by DSLN. Sounds great? Unfortunately, how many people shop for phone service at Staples? Is it not more likely that people will shop for phone services, including DSL, from the phone companies themselves?
Quarterly Results:
On November 1, 1999 DSLN reported it first results as a public company. The numbers should not have come as much of a surprise to anyone, considering that the deal was priced AFTER the quarter was finished!. DSLN holders who did their homework should not have been surprised
What is surprising is, on a relative basis, how tiny a business DSLN really is.
Lets compare the 3rd Quarter for DSLN and competitor COVD:
DSLN Revenue $ 318,000
COVD Revenue $19,100,000
COVD is 60 times larger than DSLN in terms of revenue.
DSLN Network Costs (COGS) $2,274,605
COVD Network Costs (COGS)$16,694,000
COVD, although 60x larger, only spends 7.3x as much to operate their network! COVD has positive gross margin, DSLN negative gross margin.
DSLN SG&A $3,500,000
COVD SG&A $37,697,000
COVD, although 60x larger in revenue only spends a little over 10x more in SGA expense.
Here is a VERY interesting line item, the entry for stock-based, or deferred, compensation.
DSLN Stock Based Compensation $796,109
COVD Deferred Compensation $1,008,000
So, even though COVD is 60x larger than DSLN, (and has over twice as many more employees) they are not paying themselves nearly as much in stock as DSLN insiders are paying themselves.
Finally, lets look at the market caps of these 2 companies.
DSLN Market Cap $930 million
COVD Market Cap $3,664 million
So, although COVD is 60x the size of DSLN in revenues, has positive gross margins and pays themselves less in stock, the company is only 3.93x larger than DSLN in market cap.
Conclusions:
DSLN's market capitalization is not justified.
1. The company had significant difficulty going public, changing lead underwriters and changing the size and price of the deal several times.
2. The Microsoft deal is not unique to DSLN.
3. The Staples deal is of questionable value, since Staples has yet to prove they can successfully market mission-critical communications services in addition to pens, pencils and paper clips.
4. The company's results are laughable. COVD is 60x larger. Northpoint is 19 times larger. Not only is DSLN tiny compared to Covad, but the shares are actually more expensive based on Price to Sales! In most Internet investments the better company has the higher valuation. In the case of DSLN and COVD, the opposite appears to be true, for the moment. This is not a sustainable
situation. Based on comparable company analysis (COVD vs DSLN) DSLN should have a market cap of 1/60th that of COVD, yielding a figure of only $60 million, or $1 per share.
However, lets give DSLN the benefit of the doubt, and (although there is no evidence to justify it) assume they are twice as smart and twice as good businessmen as the COVD folks. So, let us then value them at 1/30th the value
of COVD, yielding a market cap of $120 million or $2 per share. On top of that, lets add back the cash (which DSLN is actually burning through) giving a value of $174 million, or $2.90 per share.
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