Full report from Vik:
The first page of the report was the same thing I posted earlier, so I will pick up on the 2nd page of this full report:
REFLEXIVITY AT ITS BEST
For the record, we, like you, are massively surprised and disappointed by the shortfall in PSIX’s 3Q00 results and 4Q00E
guidance, especially on the heels of positive guidance from the company two weeks before the end of the third quarter.
Obviously, management made an ill-timed bet on the e-business services sector by buying Metamor Worldwide and investing in Xpedior,
just before the short-term demand curve of the Internet took a turn for the worse and shut down the supply of capital for so-called
“Internet stocks”. We view the company’s decision to exit its stake in XPDR and certain non-core pieces of Metamor as a quick move to
cut sizable losses in a segment that changed faster than anyone could have imagined. What would you have done if you had already
committed to such a transaction earlier this year?
Despite the turmoil in PSIX’s business model, we do not think the sale of non-core low-end consulting operations changes the
company’s course, nor do we view it as an annihilation of the company’s global Internet supercarrier strategy, as apparently
many of our competitors do. Management at PSIX has typically been one step ahead of the competition but behind the eight ball when
it comes to meeting Street expectations. We think that is about to change in a major way, maybe in part because new blood is coming to
the company at its Board, corporate and operating levels. PSIX still retains strategic portions of Metamor to strengthen its bundled service
proposition to corporate customers. Specifically, the company is keeping every part of Metamor that helps customers get up and
running in their Internet solutions businesses. Hosting, access, and e-commerce transaction processing services (in 160
currencies) will still be integrated with customers’ back office systems. This unprecedented bundle, in our view, continues to
position PSIX in the sweetest spot of the market with regard to winning complex e-business contracts from corporate customers
worldwide, especially as the Internet becomes mission-critical going into the new millennium.
We strongly note similar, albeit cleaner, moves by emerging telco “bellwethers” that validate PSIX’s decision to have a strategic consulting
arm within its organization. Witness Metromedia Fiber Network’s (MFNX $21 5/8, STRONG BUY) $1.3 billion purchase of SiteSmith
to strengthen its managed services capabilities and enhance its significant data center business, AboveNet Communications, itself acquired
for $1.5 billion last year. Curious that SiteSmith, with $20 million in annualized revenues, and AboveNet, with several collocation centers
and an estimated $50 million in annualized revenues, were purchased for a cumulative price of $2.8 billion, which is about where PSIX is
now being valued with regard to its common stock, preferred shares and long-term debt (now trades at an attractive 40%+ yield). We note
that PSIX has much more assets deployed than SiteSmith and AboveNet, including 14 Tier I data centers encompassing one million gross
square feet of space (by year-end 2000), a multi-terabit capable global fiber-optic network, a strategic consulting business generating several
hundred million dollars in annualized revenues (includes XPDR), and large access, transport and transaction processing businesses
generating annualized revenues approaching $1 billion. Using the SiteSmith/AboveNet transactions as a benchmark, and noting
purchase prices paid for ISPs much smaller than PSIX, such as Verio (got $6 billion, or several times 2001E revenues, in an all
cash transaction from NTT – NTT $46 5/16) and SplitRock (fetched over $2 billion from McLeod – MCLD $17 3/16), PSIX
appears attractive to us at current prices for both debt and equity investors.
We hate to frame it under the auspices of a takeout, but our competitors seem to be forcing this issue by calling for a bankruptcy for PSIX
in 2001. Given the fact that PSIX is the last independent, global, facilities-based, business-focused ISP remaining, we think it is highly
unlikely that its shares will remain at current levels, which ascribe the company a very low revenue multiple of approximately 3x and a very
low gross PP&E multiple of 2x. On its own or through an orderly auction process, we see PSIX at an enterprise value of several billion
dollars, or a share price in the double-digits, sooner rather than later. And contrary to popular opinion, we think management could sell
the company within a very short period of time for a significant premium to current prices to a RBOC, IXC or PTT seeking to
initiate/accelerate its own global Internet and data ambitions. There is a veritable laundry list of suitors/partners for PSIX – we see
BellSouth (BLS $46 ½), SBC Communications (SBC $57 3/16), Qwest Communications International (Q $47 1/4), Level 3
(LVLT $39 13/16, ACCUMULATE), 360networks (TSIX $18 3/4), AT&T Business Services (to be carved out of AT&T – T
$22 7/16), Deutsche Telekom (DT $35 9/16), Telefonica (TEF $58 3/8), France Telecom (FTE $106), and NTT as potential
bidders for the company in today’s “eat or be eaten” environment. Show us another optical IP asset that these telcos could purchase
that has a similar global reach, product set, customer base, and low valuation to PSIX, and we’ll show you some ocean front property in
Utah. Simply put, to our knowledge, there is no standalone company like PSIX available for consolidation by large carriers – that’s
exactly what makes this story unique and provides a meaningful backstop for investors worried about a fire sale out of
bankruptcy. Supply and demand mandates that PSIX, despite its near-term issues, remains a BUY for investors even in light of recent
downward revisions to guidance and the need to meet a $500-600 million funding gap – in our view, this company will undoubtedly go the
way of DT, Qwest, or some other large carrier with global ambitions because of the inherent attractiveness of its global assets.
SHAKE, RATTLE AND ROLL
Reflecting the shakeout currently underway in the Internet sector, with capital wells running bone dry, “dot.com” companies
have stopped rampantly throwing money at e-business solutions providers. In addition, brick-and-mortar companies have
become very discriminating, tapering their spending on Internet/e-commerce sites. We think the changed spending patterns of
Main Street companies is due to the following: (1) they do not need to play catch-up to the waning dot.com upstarts, who are more likely
than not to fail given the meltdown on Wall Street; and (2) they are holding up planned spending on Internet initiatives to basic return on
investment (ROI) filters, focusing on deploying solutions that promise to do more than just get their brand name out on the Web. Yes, as
the pundits have been saying for years, Business School 101 has finally rained on the Internet parade – there is no free lunch even on the
World Wide Web. Across the board, emerging e-consulting services companies like XPDR and even sector bellwethers like Marchfirst
(MRCH $5 9/16 – the combination of US Web/CKS and Whitman Hart) have been rocked during this transition period, writing down
doubtful accounts receivables from weakening dot.coms while struggling to maintain profitability due to overstaffed conditions, which
results in sub-par margins and low utilization rates for consultants.
Listening to the recent earnings calls of e-business integrators leads us to believe that this transition period is being driven by a
lengthening of the sales/deployment cycle for complex solutions to at least six months from 60-90 days, as demand from early
adopters fades and traditional corporate buyers selectively extend their real world businesses to the Internet. We think this
transition period is currently at its peak and expect it to last into spring 2001, at which time we foresee an accelerating wave of
adoption of high-end managed Internet solutions by corporations in all areas of the marketplace. We believe the secular trend for
strong growth in Internet solutions remains intact – currently only 5% of brick-and-mortar companies have truly extended their operations
to the Internet. Because it provides significant efficiencies for corporations of all sizes, we estimate that over two-thirds of traditional
companies will use the Internet for at least one of the following within the next few years: supply chain management (SCM), customer
relationship management (CRM), human resource management, and sales and marketing. This kind of activity, and more importantly a
resumption of a strong positive secular trend with regard to deployment of e-business solutions, bodes extremely well for PSIX.
IS THE INTERNET’S REACH REALLY BEYOND ITS GRASP?
Most Internet stocks are at their two- to three-year lows, but the sector’s capitalization as a whole is still up considerably over the past few
years. Look at the three-year charts of household Internet names and we think you will agree that the Internet is creating tremendous value
for many investors. As in any major growth industry, we think a small group of powerful names will emerge that will create considerable
wealth for their stakeholders. In the early 1900s, there were hundreds of automobile manufacturers, all trying to become the leaders of a
sector that went on to change the way we live (and breathe). Similarly, in the media industry, dozens of production companies and content
developers jockeyed for position to bring entertainment to the masses in theaters and through radio and television. In both instances, the
cast of characters was whittled down to a handful of players that now dominate the market due to the economies of scale and scope
inherent in serving an increasingly global market. While it may be an imperfect correlation because it is so very fragmented, we think the
World Wide Web is a similar major opportunity for growth, albeit more lumpy in terms of its trajectory than anyone had previously
anticipated, that will culminate in the creation of a handful of global supercarriers and content providers with massive scope and scale in
terms of network footprint, products and services, and/or customers.
(This is getting lengthy, let's do a Part 2)
cg |
