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Hosting pioneer Exodus waves a white flag

By Jennifer Mears
Network World, 10/01/01

SANTA CLARA - Exodus Communications, the firm that virtually invented Web hosting and went on to become a darling of the Internet boom, has filed for Chapter 11 bankruptcy protection in an attempt to reorganize its balance sheet and shed its crushing debt.

The company jumped into the nascent e-business scene in 1994 and quickly cornered a leadership position in the fast-growing Web hosting market. In its rush to build out data centers and garner market share, Exodus took advantage of the friendly capital markets and amassed $3.5 billion in debt. But then the bubble burst. Some of Exodus' biggest prospects - dot-coms and application service providers - began to fold, and the capital markets dried up.

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So while Exodus continued to sign new customers and managed to post revenue that analysts say pushed it to break even, it struggled under its heavy debt load. Interest payments alone cost $80 million per quarter, according to financial analysts.

CEO William Krause, who took over less than a month ago after founding CEO Ellen Hancock abruptly resigned, determined Chapter 11 was the only way out. While in bankruptcy protection, Exodus will not be responsible for the interest payments or other debt accrued before the filing, Krause says.

The task now is to negotiate with creditors and come up with a plan to emerge from bankruptcy protection. As an example of how it can be done, Krause points to Covad Communications, which recently filed for Chapter 11 with a prepackaged deal that eliminates its debt, giving bondholders 19 cents on the dollar and preferred stock in the company.

When it filed for Chapter 11 in U.S. Bankruptcy Court in Wilmington, Del., last week, Exodus listed $5.9 million in assets and $4.4 million in liabilities. It also said it has $200 million of new debtor-in-possession financing from GE Capital, contingent on bankruptcy court approval, which will help keep the company going.

Exodus is the biggest Web hoster in the market with more than 4,000 customers, including some of the biggest names in the business such as Yahoo, eBay and Microsoft. It has 5.6 million square feet of space in 44 data centers worldwide, but analysts estimate it's running at a 30% utilization rate, and as low as 10% in some facilities.

"Their business model was essentially building ahead of demand," says Jay Slattery, an analyst with Technology Business Research. "There was this expectation that the demand for data center space was going to continue to grow exponentially. So when this demand didn't materialize, they were stuck with all these data centers."

Exodus even continued to build out after demand had slowed: Last year it acquired Global Crossing's hosting subsidiary, Global Center, and opened four new data centers in the second quarter of this year.

"They started putting customers in newer data centers without filling up the ones they had," says Andrew Schroepfer, president of Tier 1 Research. So as the market started falling off, they had a portion of each center in use and couldn't turn any of the center back to the market, he says.

Analysts say Exodus is a bellwether of the hosting industry, which now must focus on reaching profitability rather than building out facilities and chasing market share.

It's a focus Krause says he's committed to.

"The fundamental focus for Exodus is managing for profitability vs. revenue growth at any cost," Krause says. "During the dot-com boom, it was market share and revenue growth at any cost. And it's easy to get caught up when the line is going from the lower left to the upper right at a 60-degree angle that it's going to go on forever."

It didn't go on forever - but that doesn't mean the Web hosting business is inherently flawed, analysts say. Market research firm IDC estimates the market will grow from $7 billion this year to nearly $25 billion in 2004. Much of that revenue comes from higher-revenue-generating managed services that are demanded by larger enterprise customers. Exodus has been moving into that area, distancing itself from its dot-com customer base and its roots in collocation, in which it provided nothing more than living quarters for Web servers. In the second quarter, the company reported 63% of its customers were corporations compared to 45% a year earlier.

Analysts say Exodus must hang on to that customer base as it restructures. Already, some customers are planning to move out of Exodus' facilities, although most seem ready to stick it out, albeit with contingency plans in place.

"We have been in close contact with Exodus and we don't anticipate Exodus' filing for bankruptcy will have any immediate or significant impact on Yahoo service," says Kevin Pimmons, director of operations at Yahoo.

"We understand [last week's] events are a positive step for Exodus, and we will remain a partner of theirs," he adds.

Bankruptcy basics

Many people believe that filing for bankruptcy protection means "the end" for a business. While that's true in a Chapter 7 bankruptcy filing, in Chapter 11, filing for bankruptcy is only the first step in a process that can see the business reorganized, sold to another company or liquidated.

In a Chapter 7 filing, the business is committed to liquidating its assets. A trustee is put in charge of the business, sells the assets and tries to satisfy the demands of any creditors.

"If there's no prospect of reorganization, businesses will file for Chapter 7," says Christian Onsager, general counsel to The Broe Companies in Denver and a faculty member of the American Bankruptcy Institute, an organization dedicated to bankruptcy research and education.

In a Chapter 11 filing, the management of a business maintains control and can either liquidate the company or file a reorganization plan.

The reorganization involves negotiating a deal with creditors. Even if creditors refuse to accept the terms of the reorganization, they can, under certain circumstances, be forced to make a deal with the company.

Many reorganizations involve creditors getting a fraction of what they are owed in cash as well as some stock in the bankrupt company.

As part of the reorganization, bankrupt firms can sell off certain assets or business units. If a reorganization won't work, the company can be liquidated.

	The writing on the wall Exodus' many trials and tribulations
April 26 Exodus posts $118.3 million Q1 loss and cuts capital expenditures by $300 million.
April 30 CFO Marshall Case resigns.
May 1 Exodus confirms COO and chief marketing officer are leaving.
May 9 Exodus announces it will cut 675 jobs, or about 15% of its staff.
June 20 Exodus lowers its revenue projections and announces another round of layoffs.
July 26 • Exodus posts Q2 loss of $138.5 million. • Exodus reports cash reserves of $616 million, down from $1 billion at end of Q1. • Exodus says it expects to end the year with $200 million in cash, but says it is looking for more funding.
	August 7 CEO Ellen Hancock tells Network World Exodus would consider take-over offers.
August 23 Three members of the Exodus board of directors step down
	September 4 Hancock abruptly resigns, board member William Krause takes over as chairman and CEO.
September 26 • Exodus files voluntary petition to reorganize under Chapter 11 of the U.S. Bankruptcy Code. • Exodus receives $200 million from GE Capital, pending bankruptcy court approval, to help fund operations during restructuring.

Hosting pioneer Exodus waves a white flag

The writing on the wall Exodus' many trials and tribulations

The writing on the wall
Exodus' many trials and tribulations