INTER@CTIVE WEEK
JUNE 03, 1996
Is PSINet's Repositioning Too Little, Too Late?
By Will Rodger
PSINet Inc. was connecting businesses to the Internet long before
commercialization of the research and academic network of networks was
cool. But misguided attempts to capitalize on consumer interest in the Net
and botched acquisitions mean PSI's own future is cooling --and the
Herndon, Va., company is quickly becoming an object lesson in how companies
can lose their way even amid the hypergrowth of the Internet.
PSINet Chairman William Schrader stands at a white board in his office,
sketching out the direction in which he will take his Internet services
company over the next five years.
Schrader talks about the superiority of his network, the number of top
engineers he commands and the problems other companies have had making it
in the Internet business. He peppers his talk with references to the
Internet Protocols his engineers invented. Growth, he said, will continue
unabated at least to the end of the century.
And the new chief operating officer, Pete Wills, a former networking
manager at Xerox Corp. and systems administrator at IBM Corp., will
coordinate that growth.
Schrader exudes optimism.
But the future is clouded by the present. The company lost $53.2 million on
revenue of $38.7 million in 1995, or the equivalent of $1.78 a share. Then,
in the first quarter of 1996, the company lost $14.9 million on revenue of
$17.2 million, or 39 cents a share.
By mid-May, the company decided to end its attempts to provide access to
the Internet to "low-end" consumers. PSINet made it clear that it was for
sale, retaining Merrill Lynch & Co. to help it review its strategic
alternatives and adopting a poison pill that makes it expensive for any
company to attempt a hostile takeover.
Fears that AT&T Corp.'s entry into the access business would only worsen
PSINet's prospects helped drive its stock price as low as $6.75, from a
high of $29. It now trades at $15, as of May 30.
As a result, whatever future PSINet has is not likely to include
independence.
Fact is, Schrader told shareholders at their May 18 annual meeting that it
was unlikely the company would be independent five years from now.
A 50-50 Chance
AT&T, he predicted, will get trounced in the Internet access market. "Of
course, that still doesn't mean we shouldn't sell to them," he told
shareholders. And he said there was a "50-50 chance" the company will be
sold before this year is out.
That wasn't the way it was supposed to be. For nearly 10 years, PSINet,
UUnet Technologies Inc. and a host of smaller companies supplied so-called
"advanced services" connecting to the Net and found themselves in a haven
safe from larger competitors.
The market was simply too small and the legal strictures too large to
attract Baby Bell telephone companies, for instance.
White-hot growth even let these long-standing Internet access providers
lose money along the way, in the belief profits later would more than make
up for it. But telecom reform changed all that. Suddenly, everyone wants to
get into the business, and PSINet, once the expert nonpareil for connecting
to the Net, can't find a buyer.
Meanwhile, PSINet's barely profitable nemesis, UUnet, managed to sell
itself to MFS Communications Co. Inc. for $2 billion.
"I think what happened is PSINet forgot to keep moving," said Internet
historian Peter Salus. "It's like starting the ball rolling and letting it
get away from you."
What got the ball rolling was an announcement just over a year ago that
PSINet -- then calling itself Performance Systems International -- was
going to be a major player in consumer Internet service. In February 1995,
it bought New York's The Pipeline Network Inc. for stock worth $11 million
and planned to go national with it.
The company then made other rapid acquisitions. In June, PSINet announced
it was buying InterCon Systems Corp., also of Herndon, which made access
software, and Software Ventures Corp. of Berkeley, Calif., which develops
mail, bulletin boards and other Internet software. PSINet paid roughly $36
million in stock and options for the two companies.
Between the Pipeline service, its recently launched InterRamp service aimed
at supposedly more sophisticated computer users and the ambitions of
InterCon to knock off Netscape Communications Corp.'s Navigator browser
with its own NetShark product, PSINet officials figured, the company had
everything going for it.
Pipeline: A Write-Off
They were wrong. Revenues from the consumer side -- some 30 percent of the
company's business -- never translated into earnings.
Pipeline, once praised as the easiest to use Internet service anywhere,
will cease to exist by the end of the summer, leaving the service founded
by cyberpioneer James Gleick a near-total write-off. InterRamp, still a
solid stand-alone Internet connection, will be relaunched under the
Pipeline name.
The decision to buy the two software companies "was a mistake," Schrader
admitted. "The leverage we thought we could bring to those two companies is
not as strong as it could be."
Software Ventures and InterCon sold nearly $1.6 million in the first
quarter of this year, for an annual run rate of more than $6 million. In
1994, the two companies sold $12 million of software on their own.
The chairman's revival plan goes something like this:
Capture about 10 percent of the market for consumers who will pay for
top-notch Internet connections. That will represent 2 million or more
customers by the end of the decade. And then add about 4 percent of the 10
million businesses that should be operating on the Net then.
A PSINet focused on high-quality connections may be too late in coming,
however.
"It's my contention they cannot survive in the Internet wars," said
Internet consultant Joel Maloff. Future operations, he said, "have to be
done with someone else."
Peter Krasilovsky, senior analyst with Arlen Communications, said, "PSINet
has never been positioned so it could compete against the telephone
companies. People like [UUnet Chief Executive Officer] John Sidgmore were
saying they were stupid going after the consumer market, and Schrader just
ignored them."
There's plenty of company, though, Schrader noted. Both AT&T and MCI
Communications Corp. have stubbed their toes trying to provide Internet
access to consumers on a broad scale. Even MFS failed to sell Internet
access on a retail basis.
It's a far cry from when Schrader and former Chief Technical Officer Martin
Schoffstall started Performance Systems in 1990. Though they had run the
not-for-profit Nysernet, a regional access network, selling connections to
the Net was still new. Only UUnet and a handful of others had tried it
before.
Revenue in the first year topped $3.1 million, leaving the company $294,000
in the red. By 1992, the company had more than doubled sales and wiped out
the first year's deficit. The next year, total revenues hit $8 million;
1994 saw a top line of $15 million. Losses returned in those two years,
totaling $7.2 million, but seemed manageable.
A final private placement and two public offerings raised nearly $150
million for PSINet, placing it firmly among the giants of Internet service.
But the very qualities that made Schrader and Schoffstall pioneers may be
the same ones that make others think PSI's best days are over. They may
well be start-up artists, not executives who can run large companies.
Enter: Wills.
Hard As Nails
If nothing else, the troops the new chief operating officer will lead are
hard as nails.
So tough is the company culture, in fact, that PSINetters are routinely
referred to as the Hitler Youth. Aggressive to a fault, the company quickly
earned a reputation for meanness and obsession, combined with a large dose
of top-down control.
Take, for instance, the case of InterCon Systems. Founded in 1988 by PSI
Vice President Kurt Baumann and entrepreneur Michela Barry, InterCon was as
anti-corporate in mentality as any company could be. Employees worked long
hours as a rule, but largely kept whatever hours they preferred, as long as
assignments got done.
Tropical birds -- loud and spontaneous -- served as mascots to programmers
and salespeople alike, helping to break up the mind-numbing monotony of
routine programming tasks.
Pranks, Nerf-ball battles and Super-Soaker water gun wars broke out when
things got dull. One executive returning from vacation a day later than
scheduled found a blank wall where his door had once been.
Culture Shock
But the shenanigans changed when InterCon sold out. PSI executives quickly
removed InterCon Chairman Baumann from his former post and appointed him
vice president of consumer services at PSINet.
Corporate secretary Barry was unceremoniously escorted from PSI
headquarters only hours into her first day as a PSI employee and given no
duties for the remainder of her one-year contract.
And Gaige Paulsen, a twentysomething chief technical officer who wrote the
original versions of many of the company's programs, suddenly found himself
president of the company.
Water guns and tropical birds disappeared. As did business. Sales dropped
more than 25 percent within six months of the takeover and are now half
their pretakeover level.
Schoffstall, who oversaw the transition, "pretty much ran InterCon into the
ground," a high-ranking PSINet official said.
Even Schrader admits the move was ill-advised.
"It's a stand-alone company now," he said. "[InterCon President] David
Hudson is running the show there now, and we leave them alone."
Of Schoffstall's tenure he said little. "He was a good small-company
manager," Schrader said. But, "PSINet is no longer a small company."
Also harmful was Schoffstall's flirtation with multiplayer gaming and
cutting-edge switching technologies, such as the super-speedy but still
unproved Asynchronous Transfer Mode, or ATM, technology that PSI -- lone
among serious Internet access providers -- built into its network.
Schoffstall believed that serving businesses on the Internet was a dead-end
street.
He began pushing relationships with interactive gaming companies, such as
Mpath Interactive, a Cupertino, Calif., company backed by SegaSoft.
Mpath Interactive is developing technology to let players compete in action
games on the Net without delays and talk to each other along the way.
But he wanted to go beyond just supplying games over the Internet. In
essence, analysts said, he wanted games, videoconferencing and other new
media technologies to come first, and the rest of the Internet second. The
challenges and costs proved too much for the rest of the company to
support.
"He felt it would be a $2 billion industry in short order," Arlen's
Krasilovsky said.
"It was lunacy. He was five years ahead of what was possible, and that's
certainly not the sort of thing PSI should be." |
