I just went back and looked and it was briefing.com not barrons that had the piece:
09-Jul-01
The Exodus Debt Problem and Coming Bankruptcy [BRIEFING.COM - Robert V. Green] Few companies have as big a debt problem as Exodus Communications. The problem with debt, of course, is that you must make the interest payments, regardless of all other conditions of your business. Exodus appears headed into a scenario where the interest payments will be larger than their gross margin. For a billion dollar company, that is unsustainable.
The Size of The Debt
Just how big is the debt?
Here's a list of the individual debt securities outstanding at Exodus (EXDS):
Note Due Date Amount
5% Convertible 2006 $52.8 million
4 3/4% Convertible 2008 $500 million
5 1/4% Convertible 2008 $575 million
11 1/4% Note 2008 $275 million
11 3/8% Note (Euro) 2008 $176 million
10 3/4% Note 2009 $110 million
11 5/8% Note (Euro) 2010 $1,000 million
Other varies $407 million
Total
$3,470 million
That's almost three and one-half billion.
The Payment Problem
The problem is really quite simple. They don't make enough money to both make the payments and run the business. They aren't even close.
The Q1 quarterly earnings report shows the extent of the problem in two basic numbers:
Gross margin (revenue minus cost of goods sold): $92 million
Interest expense: $70 million
The interest expense will be larger in the soon to be reported quarter, because the most recently raised $500 million occurred in February. The gross margin will also decline, due to lower revenues.
Our analysis shows that in Q2, Exodus will report a gross margin of only $80 million, only $5 million more than the interest payments that will be due.
That leaves virtually nothing in the operating model for operating expenses. It should be obvious that this is no way to run a business.
The Way Out?
Two things have to happen simultaneously, before Exodus runs out of cash, to survive.
Revenue grows quickly to cover both operating expenses and interest payments.
Expenses are cut to a level where the gross margin covers both.
Revenue: Two strikes against Exodus here.
The first strike is that revenue is already declining. The coming quarter is going to show revenue of $315 million, versus $348 in Q1. With an across the board recession in technology companies, you can't count on Exodus somehow being immune. Any belief in explosive revenue over the next year is foolish.
The second strike is declining gross margins. In the most recent quarter report, Q1 2001, the gross margin fell from 29% in 2000 to 26% in the most recent quarter. This means, even if Exodus grows revenue, they now have to grow the top line faster than before, because each revenue dollar costs more to operate.
Expenses: Even severe cuts don't help enough. Operating expenses were about $150 million in the most recent quarter. Even if you make the overly aggressive assumption that 50% could be cut, and still run the company, that's $75 million a quarter.
So, even at the most simple cash-flow analytical level, and giving Exodus the benefit of extreme assumptions, Exodus probably will miss an interest payment far before the principal is due. Here's why.
Interest payments (fixed) at $73+ million plus expenses (after generously giving them a 50% cut), equals $148 million per quarter. To be able to make both expense and interest payments therefore requires a gross profit of $150 million a quarter. At a gross margin of 30% (last year's rate), it requires revenue of $500 million a quarter, or 60% more than the current quarter.
If you don't give Exodus any expense reduction, they need to grow revenue to $750 million a quarter to reach breakeven.
Exodus must reach revenue levels somewhere between $500 and $750 million each quarter before they run out of cash.
Cash
How long does Exodus have?
At the end of Q1, Exodus had $1 billion in cash. But, as a result of opening three additional data centers in Dallas, Amsterdam, and Paris, Exodus will only have about $550 million in cash at the close of June 30.
Add up: gross margin of $80 million (Q2 estimate by Briefing.com), interest payments of $(75) million, operating expenses of $(150) million, and you get real cash losses around $145 million. This is pretty close to Exodus stated expected loss of $140 million for the coming quarter.
With operating losses around $150 million per quarter, and $550 million in cash, Exodus runs out of cash in less than one year.
Acquisition?
Will someone rescue Exodus, and Exodus shareholders, by acquiring the entire company?
The debt, at more than $3 billion, makes the total acquisition cost more than $4 billion. The only reason to acquire Exodus would be to add hosting to an existing product line, meaning it would probably be someone already owning internet infrastructure and expanding. That would make Genuity (GENU) a far more reasonable acquisition. At roughly the same revenue level, and current market cap, but with only $58 million in outstanding debt, Genuity would provide hosting facilities and internet infrastructure at far lower cost.
More Capital?
The capital markets are not likely to bail out Exodus.
After all, Exodus just burned the capital markets in February for $750 million. They sold 13 million shares at $18.50 and $500 million of seven year 5 1/4% notes, convertible to stock at $22. With the conversion laughable now, and five year CDs at a bank still bringing close to 5%, it is safe to say there isn't a single happy holder of the February notes, and it is only five months later. And the new shareholders have lost 90% of their money in those same five months.
The capital markets won't likely tolerate another offering of any kind by Exodus.
Bankruptcy Likely
Frankly, the only likely scenario for Exodus is bankruptcy, in our view, probably declared sometime in the early summer of 2002.
It isn't polite to predict bankruptcy, and most on Wall Street won't do it publicly. You should also realize and understand that this statement is based primarily on two assumptions: first, slow to minimal revenue growth for Exodus; and second, an inability to raise additional capital. If either of these assumptions proves wrong, bankruptcy could be avoided. But, in our view, there is no evidence to contradict either of our assumptions.
An Investment Play
Before you accuse us of having the right news, but being late, allow me to remind you that Briefing.com has never had much positive to say for Exodus, except on the daytrading page. As a long term investment, we have always been pretty harsh on the business model, even as the stock rose during 1999.
So what are investors to do? Depends on who you are.
Long term holder, with deep losses: You won't ever recover the losses. Deal with the emotional part of it separately, but sell. Any rally is short lived.
Recent buyer, playing on rebound: If you get a profit situation, take it. It is ephemeral.
Want to short? Not marginable anymore, so you can't short it.
Options: Possibly the only remaining play is buying PUTS. They trade pretty thinly these days, but if you can get a long term PUT that would be profitable when the stock is trading at less than $0.25, it may work.
What Went Wrong?
The Exodus strategy appears to have been:
Build the biggest hosting infrastructure as fast as possible, and never mind the capital costs
This is the roughly the same philosophy that built Global Crossing, which ironically now owns 20% of Exodus.
After all, instead of trying the make the company have a profitable business model with $1 billion in revenue, the company raised $750 million last quarter and poured it into three more data centers.
But if you can't run a profitable business with $1 billion in revenue, what level of revenue do you need?
The Real Story
Exodus is going to be the great example of the over-zealous capital markets of the internet bubble. The company eagerly partook of inexpensive capital, seemingly as much as it could engorge itself with, and built a huge infrastructure. The company seems to have assumed that growth would continue forever! It stopped in Q2 of 2001.
Watch for Exodus' earning release on July 27. The only two numbers worth looking at are gross margin and interest paid. From now until the foreseeable future, the closer these numbers are to each other, the sooner Exodus files for bankruptcy.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com |
