Internap Network Services (INAP)
Posted on November 23, 2005
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.
Quick Introduction to this new Stock Pick:
As mentioned in prior posts, we are in the midst of a second
Internet bubble and I suspect that investors will soon start
looking to Internet infrastructure plays as the Internet content stocks
get too overvalued and opportunities dry up. History is apparently
repeating itself with this second Internet bubble and so, if history is
any guide Wall Street will be talking up Internet infrastructure plays very soon. Get on board and make some money.
And if you need proof: yesterday, Akamai (AKAM) hit a new high on an analyst upgrade. The reason: "Based on recent customer checks we believe demand could be accelerating in Akamai’s media, software distribution, and government verticals," Prudential Equity Group analyst Michael Turtis wrote in a research note. Turtis said demand for Akamai’s services has been driven by increased bandwidth consumption by media companies, which are using more streaming video on the Internet; electronic distribution of software, music and videos; and growing use of Web-based enterprise applications." And what do you know,
IIP is big reseller of AKAM´s services, so if AKAM is up, IIP is sure to follow, especially given IIP´s low valuation (see more below).
Business: Internap delivers a suite of network optimization solutions, combined with progressive and proactive technical support, which enables companies to confidently migrate business-critical applications to the Internet. This includes e-commerce, streaming audio/video, Voice over Internet Protocol (VoIP), video conferencing, virtual private networks and supply chain management. The Company currently has more than 2,000 customers serving financial services, healthcare, technology, government, retail, travel and media/entertainment markets. In plain English. Internap helps companies manage website traffic. The company is a big reseller of AKAM´s services. Interestingly, one of the companies new clients in myspace.com, which is the hottest Internet site out there. For more information, visit their website at www.internap.com
What happened here? IIP´s stock is down from over $100 during the first Internet bubble. It is now trading near an all-time low of $0.36. The reason for the drop? Do we need a reason? It´s the same Internet bubble Part I story. Stock hyped to ridiculous valuation… Huge SG&A overhead for a start-up business… Huge cap-ex needs… As losses mounted, investors fled. But wait, the Internet is for real. Maybe it´s time to reconsider all these investments in Internet infrastructure. Fast forward to 2005…
What´s to like here?
Amazingly, as IIP´s business continues to improve, the stock continues to drop. All one needs to do is to look at IIP´s last several quarterly reports and you´ll see that revenues are starting to increase, losses have been minimized (actually the company is now breaking even), and the outlook for IIP´s services has never been better. One key thing I always look for in a stock is a company that is turning from losses to profits. IIP definately fits that bill. Look for the company to show profits in 2006.
There are two more things I like about IIP:
- The company recently hired a new CEO. Now, I didn´t think the last CEO was all that bad. He actually steered IIP to profitability, but it could be that the new CEO will clear the company for a sale to a larger company. We´ll see. I´m not awestruck with the new CEO´s track record, but I don´t think IIP is a hard company to run now with the resurgence of the Internet and a lean cost structure.
- IIP has a solid cash position. As of the last quarter, the company had $42.4 million in cash or about $0.12 per share (there are 340 million shares outstanding here, the only real negative about this stock, see more below). The company´s net cash (taking out all debt) is about $30 million or about $0.09 per share. I like to buy shares when greater than 20% of their market cap is in cash.
Why is the downside now minimal? As mentioned above, IIP has a solid cash position. Plus the company´s valuation is very low. Specifically, IIP is trading for less than 1X revenue ($150 million annual revenue run rate divided by 340 million shares outstanding). Compare that to AKAM´s 10X revenue valuation. Assuming a worst case scenario, I believe the stock is worth at least 1X Revenue (remember revenue here is almost all recurring, so 1X is pretty conservative) + Cash, or about $0.52 per share. That´s a 30% increase from the current price.
What´s the potential upside here? IIP is no AKAM, so it does not deserve a 10X Revenue multiple. However, I do think that 2X revenue for a recurring revenue model with strong secular growth potential in the business is reasonable. That would put the stock at about $0.90 per share. Interestingly, in March 4, 2004, IIP sold 40.25 million shares of common stock in a public offering at a purchase price of $1.50 per share. So it is quite possible that the stock heads back to that level. If not, you can still feel happy that you are buying the stock at way beneath the last real public valuation. Overall, IIP appears to offer about 100% upside with no significant downside.
What´s the potential "fly in the ointment"?
IIP has 340 million shares outstanding, creating a huge supply and overhang of stock. They also placed 40 million shares at price way above the current market value. So in all, there is a huge amount of shares for sale in this company and alot of unhappy holders ready to dump at any opportunity. Additionally, the stock is priced beneath a $1, limiting the appeal to institutional buyers. However, what I hope and expect management to do is a reverse split that brings the stock back above $5. When this happens they can then re-list on NASDAQ. Hopefully, management will do this in 2006, after a few quarters of profitability. In any case, the actual price of a stock and its total shares outstanding has zero to do with the actual value of the business. So it pays to ignore such factors when investing and just find good companies that nobody wants at low valuations. Just buy and put them away.
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This site may include market analysis and we may own shares in the stocks mentioned in our reports. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.
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I am a long time holder of Internap and I think your analysis of the company is spot on, down to the need for a reverse split. The biggest problem the company has had has been the huge decline in bandwidth pricing, with declines of 40-50% or more over the past few years. With the long overdue consolidation in the industry, that is now slowing to maybe 15-20% but I think it will continue for a long time to come. Given that at one time close to 90% of their business was reselling bandwidth, it’s remarkable they have continue to grow revenues at all. Slow revenue growth has actually masked fast growth, but a serious decline in incremental revenue growth. In my opinion, it’s important to look at gross margins which have held steady at 47-49% - they buy bandwidth in bulk and resell it a pretty good markup - I’ve heard around 40%. ALso, their colo side of the business is growing very quickly (around 30-35% a year) and most colo customers also buy Internap bandwidth and other services. This sector has been increasingly hot - take a look at EQIX. BTW, Typepad was an Internap colo customer and had to leave because Internap ran out of space to accomodate them. This is a problem they are having now in many cities, although fortunately, they purchased huge amounts of colo for pennies on the dollar from Sprint in NYC at 111 8th Avenue. INternap is very well respected as having some of the best engineering talent and the best NOC in the business, but the company has no respect on Wall Street. I applaud you for finding this company because as you’ve said, there is almost no risk in buying at the current undervalued price imo.
Nice article. I am tracking and considering IIP for long term. Bought before around .86 let go ~ 1.50 as it was sliding in 04. - I am going to bookmark your site.
What are your thoughts regarding ISO (AMEX)? Stronger Management Team and on the cusp of profitablity as well..
Thanks again.
Scott
Thanks