PSIX: Can/Will PSINet Execute Its Bold New Strategy Successfully?
12:01pm EST 14-Jan-98 Friedman, Billings, Ramsey &Co (Ulric Weil 703-312-9565)
Friedman, Billings, Ramsey & Co., Inc.
1001 Nineteenth Street North
ArlingtonVA 22200-1722
RESEARCH Technology
Brief
PSINet (PSIX - $5 13/16) ACCUMULATE
Can/Will PSINet Execute Its Bold New Strategy Successfully?
Ulric Weil (703) 312-9565 uweil@fbr.com
Dan MacKeigan (703) 312-9666 dmackeigan@fbr.com
January 14, 1997
* Management pursues market share and expects profits in late 1999
* Plan calls for doubling of revenue in each of the next three years
* Its planned fiber network should yield significant cost advantages
* Implementing this aggressive plan requires capex of $310 million
52-Week Range: 13 3/8 - 4 1/4
Shares Outstanding: 40.4 MM
Float: 34.8 MM
Avg. Daily Volume 429,715
Market Capitalization: 234.8 MM
Institutional Holdings: 17.8%
Insider Holdings: 16.0%
Cash & Equivalents (9/97): $43.50 MM
Shareholders Equity (9/97): $58.80 MM
Long Term Debt (9/97): $26.90 MM
Book Value Per Share (9/97): $1.46
FY ROE P/E Revenue
1996A NM NM $89.76 MM
1997E NM NM $122.65 MM
1998E NM NM $236.35 MM
1999E NM NM $391.00 MM
Quarterly EPS 96A 97E 98E 99E
Q1 (0.39) (0.33) A (0.40) (0.20)
Q2 (0.28) (0.28) A (0.33) (0.12)
Q3 (0.31) (0.26) A (0.28) (0.05)
Q4 (0.42) (0.37) (0.24) 0.04
Full Year EPS ($1.40) ($1.25) ($1.25) ($0.34)
At last month's analysts meeting management laid out its latest
strategy designed to make PSINet a key global player in the value-added
internet access market. Three key points stand out 1.) besides vanilla access
enhanced with end-to- end security, distributed web-hosting, e-business
facilitation and quality of service guarantees, the Company now plans to offer
i-net telephony. 2.) The IXC deal (about to be concluded) and separate major
buys of fiber lines should help. (However, by year 2000, if not before,
a glut of OC 48-based internet backbone capacity may develop which
could drive prices down and reduce PSINet's hope for cost advantage).
3.) The Company's international expansion is continuing with the about-to-
be completed $20+ million cash acquisition of iStar, Canada's leading
ISP.
All-told PSINet's plan requires capex of $310 million over the next
three years. Management looks to vendor or lease financing. Also, the
estimated pro forma 43.4% debt to equity ratio would tolerate some debt
financing. Pro forma levels of cash (about $50 million) is not
unreasonable, but the indicated .95 current ratio is of some concern.
Interested investors, who want to learn some of the details of PSINet's
new, ambitious strategy, should read the front-page article in the
12/22/97 issue of Inter@active Week. The article appropriately depicts PSINet's
new strategy and market focus, although (almost inevitably) errs on one or two
factual items (e.g., the Company plans to lease high-speed fiber capacity rather
than pay cash). Suffice it to say PSINet's strategy sounds good, maybe too
good. At times PSINet's management has been tempted to promise more than it
delivered. That's not intentional. Especially in technology, where time is of
the essence, strategizing is easier than implementing; once a company falls
behind the curve for whatever reason it's hard to catch up. Only rich Microsoft
(and a few other large high-tech firms) can rely on an almost assured second
chance.
As to reaching positive EBITDA: because of heavy operating expenses
associated with two current deals (IXC and iStar) it now appears
investors will have to wait until 4Q98. As to true profitability: our
target is 4Q99 because of heavy additional depreciation and
amortization costs on account of the IXC and iStar deals.
Market conditions aside, investors are not happy campers: the reason
seems to be management's disinclination to be acquired at or near
prevailing, admittedly modest, industry valuation standards; this, plus
the delay in achieving EBITDA break-even has pushed the stock price to
near its all-time low.
Valued at just about one times 1998 estimated revenue ($236 million)
the shares can be viewed as being on the bargain counter. Competitors
such as non-facilities-based, consumer-oriented Mindspring and
Earthlink are valued at better than two times their estimated 1998
revenues and their share prices are near all-time highs. Last fall,
ICG Communications, Inc. acquired small business-oriented Netcom for
one+ times the latter's estimated 1998 revenue; Netcom's depressed
share price has rallied 60% since the deal was announced.
There is a message here: as the last twelve months' transactions show,
independent ISPs are valued and can be sold at anywhere from one+ to
two+ times forward revenues. But above those multiples potential
acquirers' appetite quickly fades, even for business-oriented ISPs such
as PSINet.
Recommendation: Risk-oriented investors, who for whatever reason and
on whatever basis 'smell' a deal, may accumulate the shares. Patient,
but aggressive, investors (an oxymoron?) also may begin to accumulate
figuring the stock price already discounts 'the end of the world'. At
their current price, the shares have little downside risk, and on a
take-out a potential acquirer would have to pay a considerable premium.
Risks: Cet par, ISPs are attractive acquisition targets as recent deals
evidence, e.g., BBN, Digex, Netcom. But the Street actually may believe
management's repeated assertion that at currently prevailing valuations
the Company is NOT FOR SALE. If so, the PSINet shares may not be a
rewarding investment until achievement of positive EBITDA is clearly
visible. Additionally, if the share price does not significantly rise
over the next 3 years, PSINet could topple into the hands of IXC. IXC
has a call at $23.65 on 10 million shares with the difference payable
in PSINet stock and/or cash.
Additional information on the securities mentioned in this report is
available upon request. Friedman, Billings, Ramsey & Company, Inc. is a
market maker in Computer Learning Centers. This report is based on data
obtained from sources we believe to be reliable, but is not guaranteed
as to accuracy and does not purport to be complete. Because of
individual client objectives, this report should not be construed as
advice designed to meet the particular investment needs of any
investor. Any opinions herein are subject to change. This report is
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or sell the securities herein mentioned. From time to time, this firm
and/or its directors, officers, employees or members of their immediate
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