Mass Exodus
Bull Argument
By
Todd Lebor (TMF TeeTime)
Looking for growth? Look no further than the king of Internet hosting -- Exodus Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EXDS)") else Response.Write("(Nasdaq: EXDS)") end if %>. Exodus operates data centers -- buildings that house the servers that process and store the data that you get when you point, click, and shift on the Internet.
Business is booming with the growth of the Internet, and I feel sorry for TMF Edible, my opposition in this duel. Finding a chink in Exodus' armor is like finding a picture of Telly Savalas with hair. It just ain't there.
I'll let the facts do the talking.
Exodus has grown its roster of "Who's Who" clients from 303 at year-end 1997 to 3,747 as of the last quarter's end. It added 1,462 new clients in the first three quarters of 2000. That's more than five new clients a day! With the pending acquisition of GlobalCenter, the Web-hosting unit of Global Crossing <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GBLX)") else Response.Write("(Nasdaq: GBLX)") end if %>, total customers will vault over the 4,000 mark. The combined entity will have more than 2.6 million square feet of data center space in 32 locations worldwide.
Not only does Exodus serve the major so-called new economy companies such as eBay (Nadasq: EBAY), Oracle <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORCL)") else Response.Write("(Nasdaq: ORCL)") end if %>, and Yahoo! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %>, but it also plays host to the Internet needs of Fortune 500 companies such as GE International, a division of General Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %>, and Starbucks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SBUX)") else Response.Write("(Nasdaq: SBUX)") end if %>. In fact, Exodus claims to host 40% of the world's top websites.
Impressive, eh? Well, get a load of this: Exodus had 300% revenue growth for the last 12 months, and 326% over the last five years.
Want more?
The average annualized revenue per Internet data center (IDC) customer has grown from $103,000 in the fourth quarter of 1997 to $299,000 in the most recent quarter. Let me stress that these numbers are based on monthly recurring revenue and do not include onetime fees from professional services, consulting, or installation. This promising growth is evidence that revenues are not growing through the acquisition of new clients alone. As more and more corporations begin to use the Internet in daily business, the need for full-service, mission-critical Internet hosting also grows, and Exodus is ready to serve.
Data centers are the power tools of the Internet industry. CIOs run around grunting and snorting about the around-the-clock, armed security guards that sit behind bulletproof glass guarding their redundant, temperature-controlled, fire-retardant, carrier-grade network servers. When it comes to spending money, few decisions are easier than protecting and ensuring the information flow within your company. I'll say it again. As more and more corporations begin to use the Internet in daily business, the need for full-service, mission-critical Internet hosting grows.
One of the most appealing aspects of Web hosting is its stickiness, to use an Internet term. Annualized customer churn was less than 2% according to the last earnings report. The logic is solid. Just think about it.
A typical service agreement only lasts one year, so renewal rates could be high. But, is Yahoo! going to simply unplug its servers and move them to another Web-hosting company? The ordeal of backing up those servers, physically transporting them, and praying that all goes well on hookup is too risky, thereby stabilizing the client base. Once they're hooked, they're not getting away easy.
This is not to say that Web-hosting companies can provide anything but perfect service to their customers, but I think it is safe to assume that once a client is bagged, it is more likely to remain a client than not. Especially when it is pampered with quality products and services. Which is where Exodus comes in. It is the undisputed king of Internet hosting. But, only 44% of revenues come from hosting; of the remaining revenues, 36% comes from managed and professional services and 20% from Internet connectivity.
The majority of its revenues come from monthly fees, network services, and managed services (more on these later), but Exodus also derives revenues from sales or rentals of third-party equipment, fees for installation, and other professional services. The latter are low-margin or breakeven services that Exodus offers to provide a turnkey solution -- similar to "loss-leaders" in retail.
Over the last several years, Exodus has acquired an armada of periphery companies to service the needs of the Fortune 500. It smelted these services into three divisions. The Professional Services unit provides consulting and customized solutions for each client's specific needs. Network Services keeps the hardware running like a Swiss watch. Managed Services takes a proactive role in managing the digital data in areas such as storage and security.
Perhaps Rick will take a shot at the negative earnings. Well, let's beat him to the punch.
Yes, Exodus is losing money. And yes, it has never had positive earnings. However, it is EBITDA (earnings before interest, taxes, depreciation, and amortization) positive, has been so for three quarters straight, and EBITDA is growing. In the third-quarter earnings call, CEO Ellen Hancock (#5 on Fortune's list of America's 50 Most Powerful Women) stated that net income should turn positive in the fourth quarter of 2001.
Another positive trend is that the cost of service revenues (basically operating costs) as a percentage of revenues decreased from 136% in 1997, to 117% in 1998, to 81% in 1999. This trend holds true for marketing and sales expenses, general and administrative (G&A) expenses, and product development costs. The bigger Exodus gets, the better its margins become.
With such a promising market opportunity, a Fool would be wise to be weary of competition. According to the market-data research company IDC (not to be confused with an Internet data center), Exodus had 9.3% of the Web-hosting market in 1999. Verio, the wholly owned subsidiary of Nippon Telegraph & Telephone <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NTT)") else Response.Write("(NYSE: NTT)") end if %>, followed with 7.6%, and Global Center had 5.6%. After its acquisition of GlobalCenter, Exodus will be, far and away, the 800-pound gorilla in Web hosting.
Forrester Research forecasts the Web-hosting market at $20 billion in 2004. Gartner Dataquest puts it at $25.3 billion. (How do they come up with that $0.3 billion?) The combined revenue run rate for Exodus/Global Center is $1.0 billion. You do the math. Lots of room to run.
Need I say more?
Oh. Good luck, Rick.
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