Kaufman Brothers new report lowers price target to $57.
RATING: STRONG BUY
PRICE TARGET: LOWERED TO $57 FROM $84
PLATFORM FOR HIGH MARGIN REVENUE GROWTH IN PLACE
Time to Fill the Pipe. To say the least, we are surprised at the sharp sell-off in PSIX common
shares over the past few weeks. We view recent price action in the stock as an opportunity to build
positions in one of the premiere emerging communications assets in the public market. True, the
company’s transition period this year, during which it intends to completely integrate recent
acquisitions and migrate up the Internet industry paradigm, is taking longer than anticipated, has
resulted in cash consumption above expectations, and has caused near-term results to fall just
below recent guidance. Management credibility has no doubt become an issue for the Street, as it
was when we launched coverage on the company a few years ago. Yet given the global facilities-
based business plan that calls for the development of a significant direct sales force, bundled
product set, migration of substantial IP traffic on-net, and significant investments in back office
systems, management team expertise, and brand equity, we think near-term variance to guidance is
more the norm than the exception. The reality is that over the past several years PSIX has spent a
lot of time and money assembling a daunting product set that no other company in the world can
match. This set of assets provides a significant platform for high-margin revenue growth that
should result in significant improvements in the company’s revenue mix, EBITDA outlook, and
financial results over the coming months. Negative perception aside, we anticipate improvements
in the company’s fundamentals will drive a significantly higher valuation in 2001 and beyond.
We think the company has reset expectations well below its true trajectory. In our view,
PSIX lowballed the Street during its recent reset of investor expectations and is well positioned to
outperform estimates during the next several quarters. For example, we estimate that the company
could significantly outperform guidance due to rapid deployment of 18 hosting centers, which
should turn PSIX into a cash-generating machine. The company has indicated that an average
facility, when fully loaded, should generate total revenues of $150-200 million and EBITDA of $75-
100 million during the fourth year following completion. We note that many of the company’s
mature facilities are on a trajectory to become full within less than two years of completion, well
ahead of this guidance. Therefore, we estimate that the company’s 18 planned centers (half of
which are almost complete) will throw off total EBITDA in 2004 (and maybe 2003) of more than
$1.3 billion. Thus, the company’s data center business as a standalone entity provides significant
visibility to our revised 2004 EBITDA estimate of $1.1 billion for the entire company and appears
to validate a stock price that is a multiple of recent closes.
Recommendation: We View PSIX as a Core Internet Holding. In our view, the company will
likely not remain independent if its valuation remains at the current low EV/2001E revenue
multiple of 2.5x. We believe investor apathy towards PSIX has resulted in a sell-off that is way
overdone. We look for management to quickly fill the company’s funding gap by monetizing non-
core assets, such as certain telecommunications assets of TNS, a significant global consumer ISP
with 550,000 subscribers, and portions of a $1 billion venture portfolio. As the company fills its
funding gap, delivers on recently revised guidance, and fills its global 3 terabit-capable network and
18 data centers with high end complex Web traffic/solutions, we predict an expanded valuation
that will put PSIX shares in the upper quartile of its 52-week range. Key to our thesis is our
expectation that high end Web hosting will increase as a percentage of revenues and result in
significant upward revisions to revenue quality, margins, and cash flow in 2002 and beyond. As the
company migrates rapidly into the high multiple complex Web solutions space, occupied by Exodus
(EXDS $61 1/16) and Digex (DIGX $60 7/16), we predict a return to favor for PSIX that should
result in a significantly expanded multiple on revenues for the company. Against this backdrop, we
maintain our STRONG BUY rating. We have fine-tuned our model to reflect recent guidance and
have revised our price target to $57 from $84. Note that our price target suggests an enterprise
value of roughly $14 billion, or 5.6x total 2001E revenues and 9.2x 2001E “core” revenues
(excludes the company’s consulting solutions division), which we think is highly appropriate for this
leading commercial Web-centric service provider (XSP).
September 18, 2000
Vik Grover, CFA
Communications Services
212-292-8123
vgrover@kbro.com
Erik Warren
Research Associate
212-292-8124
ewarren@kbro.com |
