Will a Swooning Exodus Attract a Suitor?


In her days as chief technology officer at Apple Computer, Ellen Hancock was known as the Iron Lady. And as the CEO and chairman of Exodus Communications (EXDS) the past three years, she has built the company into a Web-hosting giant with her characteristic determination and decisiveness. Now, some analysts think the Iron Lady might have to bend -- and seek a buyer for her company.

Exodus has amassed $3.4 billion in debt, according to the company's March filing with the Securities & Exchange Commission. And it's approaching the danger zone price for dot-com stocks -- under $2 a share. From a 52-week high of $69, its stock dropped as low as $1.60 recently, and is now trading at around $2, 97% off its peak. Analysts who follow the company believe it would be a cheap buy for telecoms such as Sprint (PCS) or AT&T (T), which are looking to offer customers a wider portfolio of services.

On June 20, the company, which logged $818 million in revenues for 2000, lowered its revenue guidance for the second quarter of 2001 by some 13%, to $315 million, from a forecast of $360 million. That precipitated a further downgrade in the company's bonds and a flurry of reassessments from financial institutions. Standard & Poor's lowered the company's bond rating from single B to single B-, and Raymond James and Lehman Brothers both downgraded the stock from buy to market outperform.

WHITE KNIGHT IN WAITING? The company blames the revenue swoon on canceled customer orders and spending cutbacks for Web hosting. Some analysts estimate that up to 10% of Exodus' 4,526 clients have either migrated to competitors, gone under in the dot-com meltdown, or taken Web hosting in-house. In the first quarter, Exodus says it added 526 new customers, but Fred Moran, an analyst with Jefferies & Co., calculates that all but 34 of those came from an acquisition. Asked about the estimate, Exodus would neither confirm nor deny an exact figure, but it did allow that "many" of its new customers came from its 2000 acquisition of GlobalCenter, a smaller Web-hoster.

Since the end of March, the company has burned through half of its cash, leaving it with around $515 million, Exodus confirms. That's enough to last only until the second quarter of 2002, predicts Merrill Lynch analyst Thomas Watts. Exodus says it can ride the amount much longer than that. But raising additional operating capital could be tricky. With its share price so low, another stock offering would hardly raise serious money for the company.

Exodus' strategy now is to raise $500 million through asset-based financing, it says. But analysts remain skeptical. Many of the company's hosting centers and much of its equipment are leased, says Moran. If self-help fails, Exodus' best option might be a white knight, says Pascal Aguirre of telecom consultancy Adventis.

Aguirre believes Exodus could hold some charm for AT&T or Sprint. The company has been competing head-to-head with Ma Bell, putting pressure on its own hosting business, Aguirre says. An Exodus acquisition would allow AT&T CEO Michael Armstrong to enhance his Web-hosting portfolio while swallowing a competitor, he adds. It would also give AT&T some marquee accounts, such as Yahoo! Sprint could have similar reasons for buying Exodus, with hopes of shoring up its own hosting service. AT&T declined to comment on whether it's considering buying Exodus. Sprint did not return repeated phone calls.

HEAVY DEBT LOAD. Both companies have reason to want to catch up with long-distance competitor WorldCom (WCOM), which has sought to acquire Exodus rival Digex (DIGX) and already owns big data hoster UUNET. And alliances between carriers and hosters have become increasingly commonplace. Data-services provider Cable & Wireless (CWP) and Japanese telecom NTT DoCoMo (NTDMY), among others, acquired Web-hosters in the past year.

Not everyone believes Exodus would be snapped up so fast. Merrill Lynch's Watts thinks buyers might hesitate to assume the company's huge debt. And Exodus' long-term contract to use long-distance provider Global Crossing's networks for 50% of its traffic won't help either, says Watts. That agreement would leave AT&T or Sprint with less traffic for their own networks. But if the debt and the agreement could possibly be restructured, Watts says selling out would be much easier than trying to solve the company's problems independently.

Surviving as an independent is still a possibility, too. "There's always a chance that this is the darkest hour," says Jeffries' Moran, who has a hold rating on the stock. If Exodus restructures its debt, raises money, holds onto its remaining customers, and cuts more overhead (the company already announced in May that it would lay off 15% of its workforce), it could be nursed back to health, he adds.

CROWDED NICHE. However, those measures alone might not be enough. More important, say analysts who cover the company, Exodus may have to shift to a different part of the $3 billion Web-hosting market, away from emerging telecom carriers and struggling dot-coms. The company's bread-and-butter to date has been in providing physical space for telecoms to house their servers. But competition in this basic-services market is growing fierce, the result of a 50% oversupply of hosting space in North America, estimates Adventis's Aguirre. This oversupply could take more than three years to shake out, he says.

For all these reasons, analysts think Exodus may have to move aggressively into more lucrative and faster-growing services, such as caching and monitoring of Web sites and online content. Hancock insisted in an analysts call on June 20 that Exodus will remain fully funded through the third quarter of 2002, by which time the company will be cash-flow positive. The company declined to comment on any acquisition rumors for this article, and despite repeated efforts, a spokesperson was unable to provide any executives to comment on the company's strategy.

But with the tech economy worsening, the company might be looking for a buyer "sooner rather than later," suggests one financial analyst. Any further erosion in Exodus' position might force the Iron Lady to make an even harder decision -- to sell her company at a still lower price. By Olga Kharif in New York


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