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Commentary: Genuity&#039&#039s big float sinks shares

In its short history as a public company, Genuity (Nasdaq: GENU) has hit a bunch of milestones -- none of them positive.

Here's a quick recap:

  • Genuity, the Internet backbone spin-off from Verizon (NYSE: VZ), raises $1.9 billion in the largest Internet IPO and flops on its first day. Shares price well below their original range at $11 and promptly plunge.

  • Twenty-five days after its IPO, Genuity exits its quiet period and an army of 11 analysts gave the company "buy" ratings. But Wall Street hits the snooze bar. Of course, all of these analysts worked for underwriters of the Genuity IPO. Bottom line: 11 buy ratings couldn't boost shares.

  • On Tuesday, Genuity topped Wall Street estimates with a pro forma loss of 23 cents a share as sales surged 62 percent to $268 million. Once again, shares did nothing.

    So why can't Genuity get any love? Blame a big float.

    Genuity floated 173.9 million shares. That's a lot of shares for the market to swallow. In fact, most newly public companies float roughly 5 million to 25 million shares in an IPO. The timing could have been better. Genuity had to go public because the government made the Genuity spin-off a condition for GTE and Bell Atlantic merger approval. GTE and Bell Atlantic became Verizon.

    The standard IPO formula is to offer a small number of shares to boost returns. After nice gains, you hit up the market for more money. Genuity went for it all at once. And now it has nearly twice the float of rival PSINet (Nasdaq: PSIX). Genuity also competes with WorldCom's (Nasdaq: WCOM) UUNet.

    Much of Genuity's problems are merely supply and demand related. That's why some analysts (all underwriters by the way) are projecting that Genuity shares could double in 12 months as investors start looking at the company's positives.

    We won't hold our breath for Genuity's share price to budge, but the company is off to a decent start based on fundamentals.

    Sure, Genuity lost tons of cash in the second quarter, $225 million to be exact, but it did post strong sales growth. On a conference call, Genuity officials said the company's losses will peak in the fourth quarter and then begin a march toward break even. The company projects gross margin break even next year and earnings before interest, taxes, depreciation and amortization to break even the following year.

    The company is also banking on some big partnerships. Genuity bolstered sales via a partnership with America Online (NYSE: AOL), Genuity's biggest customer. The Internet backbone company also recently inked a pact with Hewlett-Packard (Nasdaq: HWP), which will sell Genuity hosting as part of an e-business services offering.

    Genuity has worked to expand its customer base -- its non-AOL revenue nearly doubled in the second-quarter. The company said sales to AOL generated about 45 percent of its total revenue in the second quarter, compared with 55 percent a year ago.

    More importantly, Genuity is transitioning its business to high-end Web hosting accounts. Sales of Web-hosting services, or the maintenance and monitoring of companies' Web sites, increased 146 percent to $27.1 million, roughly 10 percent of sales. Average new deal size for hosting customers increased to $234,000, a 75 percent increase compared with a year ago.

    Genuity could also benefit from the digital subscriber line rollout. As Internet service providers ramp up DSL installations, Genuity could show solid growth. Officials said the revenue ramp is "just getting started" in this area. The company added more than 27,000 DSL users to our national backbone network, bringing the total DSL user count to more than 64,000.

    All of those points could be bullish signals for investors -- if it weren't for that big float.