PSINet fall mirrors hopes, decline of industry

But business doesn't work like football. Even as PSINet's logo rides high on Baltimore's stadium, the Internet service provider's fortunes have fallen beyond all but the most rosy hopes of recovery. After more than a decade at the helm of one of the first major Internet companies, Schrader is being replaced. Facing bankruptcy, PSINet and Schrader serve as poster children for the most inflated ambitions of a derailed telecommunications "revolution."

At the peak of his company's run, while it was expanding into every continent with scores of new acquisitions, Schrader described the big telephone companies as "dinosaurs," or even in some cases "dinosaur carcasses." Those companies couldn't move fast enough, he told reporters, even hinting that someday PSINet might be in a position to buy one of the Old World giants.

What happened to telecommunications' Bastille Day? Real life rudely intervened: debt, an unfocused business plan, and the pressures of over-expansion. The same forces that have brought PSINet low have triggered an increasing number of bankruptcies and debt defaults in the industry, most recently including former high-flyers Winstar Communications and Convergent Communications, among others.

"This was not inevitable," said Daniel Renouard, a Robert W. Baird analyst who has followed PSINet closely. The company's ambitions grew bigger than their abilities, he said. "This was management's inability to execute and focus?They took their eyes off what they do best."

PSINet announced Monday that Schrader will be replaced by PSINet President Harry Hobbs. The longtime CEO would remain as a member of the board of directors and serve the company in an "advisory" capacity, the company said.

Schrader and other executives declined to be interviewed.

"Bill Schrader is one of the true pioneers of the commercial Internet. His founding vision led PSINet to assemble valuable assets, including one of the largest and most advanced global networks and 16 state-of-the-art hosting centers," said Ian Sharp, the Canadian businessman replacing Schrader as chairman of the board. "Given the changed circumstances within the marketplace and the company, we need to focus the company's efforts on preserving and enhancing this value."

An early revolutionary
Schrader, a biology graduate, was one of the first executives on the technology scene to become a full-fledged preacher of the Internet revolution. In the mid-1980s he helped develop one of the first backbone networks connecting university supercomputer centers and founded PSINet as the first in 1989, long before the Internet was on most business radar screens.

Throughout the company's history he was a peripatetic voice in Washington, D.C., and on lecture podiums around the world, making bold predictions about the Net's transformative powers and lobbying against laws he thought would slow the Net's growth or would expand the big telephone companies' powers.

It wasn't until the mid-1990s that the company began ramping up its ambitions to the level that ultimately proved unsustainable.

With the passage of the Telecommunications Act of 1996, a host of companies began building new data and phone networks across the country, while the simultaneous rise in Net traffic made it appear that the Internet's growth could be nearly unbounded.

Schrader and his executive team believed they could ride this wave to the top of the telecommunications landscape. When other ISPs, including companies like America Online and CompuServe, sold their network assets to telephone companies, Schrader instead began building a bigger network portfolio of his own. He "didn't trust the telephone companies" and so wanted to own his own network, he repeatedly told reporters.

Analysts point to John Sidgmore and his UUNet, another early network and hosting company, as an example of what Schrader could have accomplished by taking an alternative route. Sidgmore merged UUNet into WorldCom and has since played a critical part in that company's expansion.

Schrader and PSINet, by contrast, refused to go down this path, saying that various offers from larger companies didn't value the company nearly highly enough. Instead, fueled by borrowing and a rising stock, PSINet made 76 acquisitions of its own between January 1998 and December 2000.

Schrader "was very much right about the effect that the Internet would have on telecommunications," said Berge Ayvazian, CEO of research company The Yankee Group. But Schrader's prescience turned out to have elements of myopia, Ayvazian added. "It's one thing to act like (competitors) are dinosaurs...It's another thing to proclaim independence and self-sufficiency and go ahead without recognizing the market has changed."

Collapsing ambitions
The biggest of PSINet's acquisitions was Metamor Worldwide, a consulting company that PSI bought for more than $1.3 billion in stock in March 2000--just about a month before the Net's decline began. According to some analysts, this was the real tipping point for a company already struggling to integrate its dozens of other acquisitions.

At about the same time, senior management began bleeding out the door. The company's top financial officers--CFO, controller and treasurer--all went to other technology companies. The president and chief operating officer went overboard not long afterward, after criticism of the Metamor acquisition in the financial community had taken hold, and the stock had already begun to plummet.

Throughout these warning signs, Schrader held control of the reins. Some analysts say the company's board should have replaced him last year, but the rest of the management team's departure made it difficult.

"Ultimately he was responsible," Renouard said. "But the problem was that things spun out of control too fast."

Schrader and his team did act to shore up a quickly deteriorating financial position. They began selling the non-network acquisitions of the company. Transaction Network Services, another company bought to help with PSINet's e-commerce goals, was sold back to its original owners for less than half its original price of $700 million. Metamor, the ill-fated group of consulting services that proved so hard to swallow, was largely written off as a $500 million loss by the end of 2000, just seven months after the merger closed.

But the company remained crippled with debt that stemmed in large part from the acquisition binge. Interest expenses alone mounted to 40 percent of the level of the company's revenue in 2000. Worse, the company took "impairment charges"--re-evaluating the actual value of hard assets such as data hosting center property, and writing off businesses that had been closed--of more than $2.5 billion for the year.

As a result, total losses for 2000 exceeded $5 billion, even though annual revenues had nearly doubled to $995 million.

The company's stock price dropped to just 18 cents in late March, before the Nasdaq stock exchange halted trading. Shares were delisted from the exchange last week.

Schrader's own personal fortune, which at times totaled hundreds of millions of dollars, had already evaporated when banks sold much of his shares to pay trading expenses last November.

From the rhetoric of revolution, Schrader and his company--like so many others among the once-ambitious telecommunications upstarts--have moved reluctantly into the language of financial distress. There are no more quotes about "dinosaurs." Those Old World giants, although suffering some pain in the economic downturn, appear unlikely to disappear any time soon.

Instead it is PSINet itself and Schrader's hopes of overturning an industry, which are close to extinction. The company has said it will likely file for bankruptcy and warns that even with that protection, little of value is likely to emerge.

"Even if we were successful in any of these (reorganization) efforts, it is likely that our common stock and preferred stock will have no value," the company said in its recent annual report, a document whose red-ink riddled details were as far as possible from the optimistic tones of previous years. "We cannot, however, assure you that this strategy will be successful."

The worldwide assets Schrader amassed over the years remain valuable, and will likely be a welcome addition for some other telecommunication's company's portfolio. It is likely--as was the case with AT&T's purchase of NorthPoint Communications' assets--that a buyer may be one of the slow-moving Old World companies.

"If that (sale) had happened a year ago, we would have called it a triumph," Ayvazian said. "Happening now, we'll call it a fire sale, a bankruptcy."

For today, at least, PSINet's name still proudly adorns the Ravens' Baltimore stadium as the team prepares for the 2001 football season. By the time they reach the field to play in September, their sponsor may have disappeared as finally as last years' cheers.