Thursday, February 4, 1999

PSINet Inc.
(Nasdaq: PSIX)
Phone: 703-904-4100
Website: http://www.psinet.com
Price (2/3/99): $36 9/16

As surely as one could have almost randomly picked an oil stock and seen it run into trouble over the past year, one would have found fishing for an Internet stock winner like dipping a hook in the proverbial barrel.

Among the companies that have seen their stocks skyrocket over the past year is PSINet (Nasdaq: PSIX), one of the oldest Internet companies in existence. After starting 1998 trading at $5 a share, shareholders in PSINet have found their shares up six-fold over the past 13 months.

Mix in the market's insatiable appetite for anything Internet-related, along with speculation that the company's Internet assets may be attractive to any number of potential suitors, and you have the ingredients for the rocket fuel. Adding validity to the takeover speculation is that many competitors have been bought out over the last several years. It was a crowded field three years ago, but the company's peers have been gobbled up one by one. The table below lists some of the more salient Internet Service Provider (ISP) buyouts completed:

Target       Acquirer
BBN          GTE (NYSE: GTE)
UUNet        MCI WorldCom (Nasdaq: WCOM)
Digex        Intermedia Comm. (Nasdaq: ICIX)
Netcom       ICG Comm. (Nasdaq: ICGX)
Erols        RCN Corp (Nasdaq: RCNC)

This active mergers and acquisitions activity has left PSINet alone in its field, and the company is essentially the last "pure" Internet backbone company in existence. The color of the company's bottom line today is the same color it has always been since its founding -- red. But the market's perception of the value of PSINet's assets has changed dramatically.


Headquartered in suburban Washington, DC, PSINet is one of the oldest and largest providers of Internet-based communications services for businesses. In fact, it was the first company founded with the specific purpose of providing commercial Internet service back in 1989. The company's products and services include private IP networks, Internet access, Web hosting, network security, and various other Internet-related services geared towards corporate users. Over a quarter of all Fortune 500 companies are hooked up with PSINet, but smaller businesses also represent a large chunk of the company's sales.

In addition, PSINet is a major network operator internationally with businesses in Canada, Europe, and Asia. The company is extremely active in buying up network capacity around the world, and PSINet recently became the first independent operator to own a continuous fiberoptic Internet network encircling the globe.


Income Statement
12-month sales: $200.4 million
12-month income: ($147.1 million)
12-month EPS: ($3.06)
Profit Margin: NA
Market Cap: $1894.3 million

Balance Sheet
Cash: $282.6 million
Current Assets: $523.3 million
Current Liabilities: $122.7 million
Long-term Debt: $773.0 million
Shareholder Equity: ($26.6 million)

Price-to-earnings: NA
Price-to-sales: 9.5


The first indication that perhaps PSINet was due for flight may have come early in 1998 when the former CEO of Digex, a PSINet competitor bought by Intermedia Communications (Nasdaq: ICIX) in 1997, dangled a $10 per share cash offer in front of PSINet shareholders. Since most owning PSINet had been staring at negative returns over the past three years and the offer was almost double where the stock was trading, many thought shareholders would bite at the bait. But they blew the deal off and the stock has more than tripled over what was considered by many a decent offer at the time. Whenever industry insiders make such a statement with their own cash, it's worth taking notice.


One of the positive aspects of PSI's bullish run is that shareholders no longer need to worry about a potentially dilutive deal the company made with IXC Communications (Nasdaq: IIXC). The deal exchanged 20% of PSI's common stock for 10,000 equivalent route miles of OC-48 fiberoptic cable for use in its network. If IXC's 20% stake did not achieve a market value of at least $240 million, PSINet would have to make up the difference with either more stock or cash. With IXC's shares of PSINet now worth more than $300 million, the guarantee of value has been reached much earlier than many anticipated.

With the IXC hurdle crossed, shareholders still have to worry about the company income statement's distinctive color of red. PSINet has yet to record a single profitable quarter to-date, and it looks like any black ink is still far in the future. That is, if profits come at all. The most optimistic analyst is still calling for the company to lose $3.24 per share in 1999, which is even lower than earnings posted in the past 12 months. Negative earnings and net margins in the negative 70% range should always give investors pause.

Looking at the balance sheet, one can truly get a sense of how much money the company has lost to date. On the liabilities side, the accumulated deficit now stands at a tall $295 million and growing. The company's shareholder equity also slipped below zero last quarter, which is rarely a good sign. Recently loading up on debt, PSINet has plenty of current liquidity, but the debt also reduces the margin of error for the company. On the other hand, going to the market with a secondary offering of shares is now a viable and less-dilutive option, given the recent run in the stock.

In stark contrast to PSINet's financial statements, the Internet assets the company has built and acquired over the years are quite impressive. Those assets may make PSINet attractive to a wide variety of larger telecommunications firms looking to gain a large and immediate presence in the world of IP networks.

In short, PSINet is the type of company that defies conventional valuation. On an earnings basis, it appears the stock is nearly worthless. But, there are assets there that may prove to be quite valuable. Inherent in this uncertainty is a great amount of risk for bulls and bears alike, and the safest thing may be to just watch the company from the sidelines.

-- Paul Larson

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