Small Cap Stocks

What follows is brief summary of my thoughts on IIP, after reading thru the company´s recently filed 10Q.

Recently I received the following excellent comment from a subscriber concerning Internap (IIP):

"On the question of high costs, have you factored in the possibility that the new FCP 10 gig boxes could really take off in terms of sales? Internap has the best route control product on the market and very little real competition at the high end. These boxes will sell for around 100k when they go on the market in June and Internap’s profit margins on those boxes are around 70%. If Internap can really start to reach critical mass in terms of selling these devices, it could significantly alter the gross margins of the business. Also, given that broadband useage will go from 38 to 88 million Americans over the next 6 years or so and video is really starting to take off with Google Video, youtube.com etc. I see the demand for Internap’s FCP and IP services growing significantly. Thoughts?"

Last night Internap (IIP) delivered financial results that confirmed the strong turnaround at the company. From my perspective the most important part of the financial release was the increased revenue growth guidance for 2006, since the meager revenue growth projected last quarter was a factor in limiting the upside valuation for the company.

For those investors without access to Wall Street research reports, this post provides some notes from Stanford Financial Group´s March 1st, 2006 research report on IIP. The analyst´s target price is a bit higher than mine, primarily because I am applying a larger discount to the EV/EBITDA multiple for IIP.

Note: If you plan to link to this post or copy it in any manner, please be sure to credit:              Stanford Financial Group (Rod Ratliff)

Internap reported decent earnings results last evening. There were several positives, and a few negatives. Overall, there is clearly enough improvement in Internap´s financials to warrant holding onto to the stock, and the stock still appears undervalued primarily because the business is solid, EBITDA growth in 2006 will be excellent, and  management at IIP is still underperforming basic industry financial metrics leaving room for additional stellar financial improvements.

I´m putting a conservative $0.60 per share target on the stock, which represents about 12X estimated 2006 EBITDA. The value disconnect in the stock reflects an inept management team, but therein of course lies the opportunity for potential acquirers and current investors (i.e. fire 5% of the upper executives at IIP and EBITDA goes up dramatically). In theory, the dramatic EBITDA growth in 2006 warrants a much higher multiple, but I´m not yet completely comfortable with the current new CEO´s ability to manage the financials here, so I´d rather be conservative and wait a quarter or two before assigning a higher multiple. As an aside, if the company seems capable of meeting the high end of EBITDA projections, as the year progresses, there is no reason not to assign a value of at least $0.90 per share to IIP.

Two of Internap’s closest comps have just reported earnings, and it is interesting to compare their valuations to Internap to see the potential value of Internap, in the event of a takeover (I wish management would just put IIP up for sale already). Note that these calculations are very back of the envelope and somewhat simplistic. But, I think they give a good idea of the potential for Internap’s stock.

In keeping with my Internet infrastructure theme (i.e. RBAK, INLD), I believe that Internap Network Services (IIP) represents a good investment "gamble" at it´s current price of about $0.40 (yes, you read that right 40 cents, but don´t be scared away just yet). The company has low downside risk and significant upside as investor sentiment continues to improve towards Internet infrastructure plays.