Genuity teetering, but signs of hope remain

BURLINGTON, MASS. - Even with a stock price wobbling dangerously around $2, Genuity's prospects appear stronger than those of its ailing competitors.

The prime reason Genuity has a better shot of pulling out of its tailspin is its relationship with Verizon. The incumbent local exchange carrier owns a portion of Genuity, which has slightly eased the fears of customers and financial analysts.

"Genuity was able to mitigate our concerns about its finances before we signed our contract," says David Blauer, CEO at Click4Care, a software company that develops Web applications for the health insurance industry. "I must admit when I saw the stock trading around a buck a share, it made me nervous. The fact that Verizon is investing in Genuity gives us a sense of comfort."

Click4Care, which is using Genuity's Black Rocket fully managed hosting service, knew it wanted to outsource its application and Web server management six months ago when it started shopping for a service provider. Click4Care chose Genuity because it was more responsive than Digex and offered a fully managed service that Exodus did not, Blauer says.

While Genuity's hosting services fit Click4Care's needs, the fact that Verizon owns 9.5% of Genuity with the option to increase its ownership to 82% also helped. That option can only be exercised after Verizon receives regulatory approval to offer long-distance voice service to 95% of its customers. For Verizon to offer this service, it must prove to regulators that it is fairly opening its local markets to competition.

Because that process is dawdling, with Verizon offering long-distance service in New York and Texas, Genuity may wait a long time for a full Verizon bailout. The optimistic view for Genuity is Verizon has ample motivation to make this work.

"The bottom line is that Genuity really is Verizon's entrance into long-haul data. Without it, Verizon would be starting from scratch," says Stephen Mahedy, a financial analyst at Salomon Smith Barney. There always remains an outside chance Verizon would not convert its shares to increase ownership, but that's clearly a remote possibility, he says.

Genuity has a nationwide fiber-optic network that's on a par with that of UUNET, the nation's leading ISP, says Steven Harris, an analyst at consulting firm IDC. Verizon clearly is not going to want to build its own network.

Despite the sagging stock price, Genuity remains better off than several competitors.

Genuity has little debt compared with PSINet, which is on the verge of bankruptcy. Genuity's only debt is a short-term $500 million loan it took from Verizon earlier this year. PSINet is $3.4 billion in the hole.

PSINet also made acquisitions that proved difficult to integrate into the core business, Mahedy says. "And for all of [PSINet's] capital expenditures that went toward building its network, the return on invested capital was never completely realized."

Genuity has also been known for its technical prowess.

"Genuity has been on the leading edge of network technology offering digital certificate authentication with its VPN services for a couple of years, where others are still in the planning stage," IDC's Harris says. "PSINet's network for the most part is still IP over frame relay."

Genuity can also tout enterprise customers such as McDonalds, Sears and Honeywell, as well as wholesale service provider customers such as AOL and Deutsche Telekom.

Genuity's biggest problem is it is still building its business. The ISP plans to spend up to $5 billion in the next few years to expand its IP capabilities. And Genuity will incur operating losses, which is taboo on Wall Street.

"Basically the company is not getting credit for forward [earnings] estimates," Mahedy says. "In this environment the safe haven for investors is with companies that have lots of cash on hand, are generating free cash flow and have a long history of profitability."

Nevertheless, analysts believe Genuity will pull through.

"I'd be surprised if it became another NorthPoint," Harris says.

Surviving the storm may not be enough for customers, of course.

"We have a one-year contract with them," says Click4Care's Blauer. "If we're not satisfied we'll go right to Exodus."