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Editor's
Note: In our ongoing effort to improve this report,
we've decided this week to roll out Ragas Ratings, our new
stock rating system. In an effort to steer clear of Wall St.
analyst-speak, we've made the system very simple and straightforward.
BUY, SELL or HOLD. That's it. They mean
exactly how they sound.
Many
readers email us each week after reading the Week's Commentary
asking for particular stock picks and investment ideas. This
new rating system will hopefully help cut to the chase in
each report. After all, the bottomline for reading any investment
related report is to hopefully make money! Lots of it.
As
always, please email us with feedback and new ideas at: matt@ragasreport.com.
Web
Hosting Stocks: The Battle For Survival Among Web Hosters
Heats Up
Panic
and raw fear all rolled into one.
That's
perhaps the best way to describe the behavior of investors
in the Web hosting sector over the past six months.
While
it's clear that Web hosting will continue to hold its place
as a cornerstone of the Next Economy, a flurry of recent reports
suggest that demand for data center space is waning. Big time.
Even worse,
some research firms are now projecting that up to 75% of all
data center space available in North America will remain unsold.
We're talking serious overcapacity if these estimates are
correct.
So far,
though, it remains to be seen if these dire estimates are
anywhere close to being right. Regardless, this still hasn't
stopped Wall St. from turning the remaining Web hoster stocks
into walking pariahs.
To be
fair to these pessimistic investors, closely held Web hosting
player Colo.com has indeed already filed for bankruptcy
protection and ISP PSINet, another big Web hoster,
has officially called it quits as well.
Big deal
I say.
In my
mind, the fundamental value proposition behind the outsourcing
of a company's Web operations is still incredibly strong and
getting stronger. Web site and applications hosting isn't
going to suddenly shrivel up and die.
This is
a sector still with ALOT of growth ahead. My only real fear
is that many Web hosting shops are backed with tremendous
amounts of debt to manage. Some will collapse under the weight
and others will be absorbed.
But there
will be winners out of this mess.
With this
in mind, I decided to take a look this week at Exodus,
Loudcloud, and Globix, three of the remaining
independent Web and applications hosting stocks.
After
putting the group under my analytical microscope, let's see
what I could find out.
Loudcloud
[LDCL]
Even the
blessing of Netscape founder Mark Andreessen
doesn't seem to go as far as it used to. Everyone seems fallible
these days. Co-founded by Andressen and a team of Netscape
and AOL veterans, infrastructure services provider Loudcloud
has struggled severely since coming public in early March
of this year at a lowly $6 per share. Realistically, though,
given the abysmal IPO market and Loudcloud's extremely short
operating history, it's a wonder that this company was even
able to get public in the first place!
Loudcloud
shares are currently hovering around $2 bucks after the firm
recently reported a shaky first quarter. In addition to laying
off 122 employees, Loudcloud announced lowered revenue projections
for the remainder of the year, which prompted quick analyst
downgrades. Loudcloud now expects sales of $53-$57 million
and a loss of $129-$132 million for the remainder of the year.
On the plus side, company CEO Ben Horowitz continues
to tell Wall St. that Loudcloud has a "fully-funded business
plan." So far, Wall St. is mixed on these claims and
screaming "show me!"
While
LDCL still sports negative margins right now, there are indeed
clear long term advantages to the fact that the firm leases-
and doesn't actually own- data center space. This firm
shouldn't end up drowning in debt like some Web hosters! In
addition, Loudcloud continues to quietly rack up major new
customer wins like Fox, Ford Motor, USA Today
and Blockbuster. Given Loudcloud's strong management
and marquee backing, this firm looks like a survivor. Investment
wise, though, this is a stock to avoid for the next few quarters,
until LDCL moves closer to cash flow positive.
Ragas
Rating: HOLD
Globix [GBIX]
Founded
in the pre-Web days of 1989, Web hoster Globix has quietly
built up a strong reputation as a reliable Internet hosting
and applications services company. Headed by company founder
Marc Bell, Globix has so far maintained its independence
and now operates data centers in London, Santa Clara, New
York, Washington D.C. and Atlanta. With more than 72% of the
company's revenue now being generated from enterprise customers
(non-dot coms), Globix now boasts arguably the most secure
revenue mix among the Web hosters.
While
pundits continue to talk about a glut of data center capacity,
CEO Bell estimates that Globix's data centers are currently
operating at 95% capacity. In addition, the firm recently
![]() announced
that it had signed roughly $25 million in aggregate new contacts
in the past three months. For the most recent quarter, sales
jumped 50% to $26.8 million while GBIX's EBITDA loss declined
22% to $12 million. While this is good progress, I am still
shaken by the fact that Globix paid almost $11.7 million in
interest expense last quarter alone.
For fiscal
2001, Globix now estimates that lease payments, working capital
and capital expenditures will total $160 million. Suddenly,
the $217 million in cash that GBIX ended last quarter with
doesn't sound so impressive. At a recent price of $1.60 per
share, Globix is trading for only one-third of its cash value
and less than one-times its expected 2001 sales ($100-$105
million). Clearly, Wall St. is currently betting against this
company's survival. GBIX's debt load is indeed a frightening
site in a frigid fundraising environment. I'll pass for now.
Ragas
Rating: HOLD
Exodus Communications [EXDS]
Banking
on the demise of Web hosting giant Exodus seems to be a favorite
past time of analysts these days. In fact, over 20 analysts
now have a HOLD rating (read- sell) out on the stock. Let's
not forget that over a year ago, Exodus was THE toast of the
Street. When it came to investing in "Net infrastructure"-
EXDS was the play of choice among fund managers. So what went
wrong? A combination of data center overcapacity fears, sudden
executive departures at Exodus and a frightening cash burn-
all bunched together- have left investors spooked.
I have
to admit that I can't blame investors for driving Exodus shares
from $10 or so down to only $1.20 in the past three months.
With a $3.4 billion mountain of debt to service and only $550
million in cash on hand (as of June 30), it's easy to bet
against EXDS right now. But let's look at the plus side. With
40 data centers around the world, Exodus is the world's largest
Web hoster. Even with quarterly interest payments of $75 million
and increased competition, EXDS is still an incredibly invaluable
asset for traditional telecom firms to own.
While
investors are acting like Exodus is headed towards bankruptcy,
company CEO Ellen Hancock maintains that the company
is fully funded to reach breakeven by the third quarter of
next year. In addition, former BMC Software and McDonnell
Douglas exec William Austin joined the firm as
CFO earlier this week. Clearly he thinks EXDS can make it.
I'm going to go out on a limb and agree. At a recent market
cap of $665 million and with $1.4 billion in sales projected
for this year, Exodus' valuation just looks too tasty to pass
up.
Ragas
Rating: BUY
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