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Update: PSINet Dives 56% on Weak Earnings, Bleak Financial Outlook

Updated from 4:13 p.m. EDT

PSINet (PSIX), a provider of Internet access and Web hosting services, stunned Wall Street Thursday, offering a pessimistic financial outlook while announcing that its third-quarter revenue had fallen short of estimates and another top executive had departed.

PSINet also said it would try to sell its 80% stake in Xpedior, the Web consultant it gained after acquiring Metamor Worldwide last summer, and would dispose of other units picked up as a part that deal. Yet the potential sales of the businesses, which are dragging on PSINet's earnings, led analysts to question the wisdom of the acquisition in the first place.

A number of factors contributed to jitters about the company's future, setting off a 56% drop in its stock price Thursday. First, PSINet said Harold Wills, the four-year PSINet executive known as Pete, had stepped down from his post as president and chief operating officer. Wills formerly worked as chief operating officer for Hospitality Information Networks.

Another High-Level Resignation

Explaining Wills' resignation in a statement, William Schrader, chairman and chief executive of PSINet, thanked Wills for his "contributions," but added that this was "the appropriate time for the company to move in a different direction."

But for some who follow the Ashburn, Va.-based company, Wills' exit fuels worries about the course the company has plotted, because it comes on the heels of two other recent high-level resignations, and it hits PSINet at a time when it is continuing to integrate a number of acquisitions.

"The timing is rather inopportune," noted Riyad Said, an analyst at Friedman Billings Ramsey & Co. "It's certainly not encouraging."

Earlier this year, Edward Postal, the company's chief financial officer, left to join Cidera, a start-up, and Lawrence Winkler, its treasurer, defected to a wireless company in California. In addition, Michael Mael, a vice president who oversaw the company's Web hosting business, one of PSINet's bright spots, also departed the company this year.

"We think some conflict of opinion or style with Schrader caused him [Wills] to leave the company," said Frederick Moran, an analyst at Jefferies & Co. "Bill is know as an executive who's somewhat difficult to deal with and fairly stubborn. And now the key executives around him have departed, leaving him with a stock that's a shell of its former self."

Shares of PSINet plunged $3.84, to a 52-week low of $2.94 on Thursday. It was just several months ago, at the beginning of the spring, that PSINet's stock had hit a perch of $60.94.

Lawrence Hyatt replaced Postal as CFO over the summer, and one analyst, Stephen Mahedy of Salomon Smith Barney, said in a research note at the time that he was "cautiously optimistic" about the appointment. He said the move likely would stabilize the management team.

Revenue Woes

Aside from those key executive losses, PSINet has plenty of other issues to rectify. Although revenue increased 27% from the previous quarter to $352.5 million in the latest three-month period, it failed to reach a level of at least $400 million analysts had projected.

Stoking skepticism, PSINet said it likely would miss fourth-quarter financial targets, and at the same time said it would conduct a "thorough financial and operational review of the restructured organization" rather than give analysts much guidance.

The company, which hired a subsidiary of Ernst & Young to help evaluate its business, pledged to give analysts a more detailed financial prognosis before it unveils its annual results in February -- but it may take some time to turn critics into believers again.

"They've lost their credibility on Wall Street," said Moran, the Jefferies analyst, who rates the stock a hold and has a set a $4 price target for the company, which he said he will keep until PSINet "brings some clarity." His firm has not done any underwriting for PSINet.

Saying that "current market conditions are quite challenging," PSINet said in a statement that its board of directors would decide whether to remain an independent company or to seek "other strategic alternatives."

New Strategy

PSINet is shifting its focus away from providing Internet service, an increasingly competitive undertaking, to offering Web hosting, a hotter, high-margin business, and electronic-commerce services. Looking to extend its e-commerce reach into corporate America, PSINet acquired Transaction Network Services in August 1999, and Metamor in mid-June of this year.

Now however, PSINet said it had hired CS First Boston to pursue the sale of its stake in Xpedior, and Lazard Freres and Daniels & Co. to assist with the valuation and sale of certain consulting businesses acquired as part of the Metamor transaction.

"Either management doesn't know how to size up its acquisitions," Moran said, questioning why PSINet brought the low-margin businesses into its fold to begin with, "or it doesn't know how to execute."

PSINet recorded a net loss in the third quarter of $1.4 billion, or $7.34 a share, which included restructuring expenses, asset write-downs and other charges, compared with a loss of $82.3 million, or 68 cents a share, a year earlier.

The company, meanwhile, posted an operating loss of $182 million, or 95 cents a share, compared with a predicted loss of $1.28 cents a share, according to First Call/Thomson Financial.

Back in September, PSINet warned that revenue in the second half of the year would be $920 to $960 million, compared with an expected $1 billion, blaming weakness in its carrier access business and losses from Xpedior, which like others in the Internet consulting sector has struggled to cope with a slowdown in dot-com spending.

At the time, the company also said it would need to raise an extra $600 million, possibly by selling assets, by the end of 2001 to finance its growth and shift to focusing on hosting companies' Web sites.

PSINet recently opened new Web hosting and e-commerce centers in Canada, the Netherlands and Korea, but said it would delay the construction of sites that were scheduled to open in 2002 in order to achieve spending cuts of up to $200 million.

"Now it's a question of how can they best redeploy their assets," noted Said, whose firm rates the stock accumulate and has not done any underwriting for the company. "The Web hosting business holds a great deal of promise. That will be a focus from now on."

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