Exodus Works Behind the Scenes; CheckFree May Not Add Up

Exodus Communications (EXDS)

Jim: Buy

Mike: Buy

*

Mike: Now this company, Jim, is one I think of as representing the part of the Internet that’s akin to the iceberg under the waterline.

Jim: I have no idea what you’re talking about.

Mike: That’s not the first time.

Jim: Tell me about it.

Mike: Exodus Communications basically provides the servers and services that actually host Web sites. Have I made anything clear?

Jim: No.

Mike: Well, think of yourself sitting at a computer. You type in a Web address, and presto! The Web page appears on your screen. In truth, what you’ve done is send a command to a computer operated by Exodus or a company like it, and that computer has snatched the Web page out of its own memory and zipped it over to you. Exodus’ servers let you see the page, often handle the online orders you might make for merchandise, provide video clips and all the rest.

Jim: So you might be looking at XYZ.com’s Web site, but it has hired Exodus to make the site work.

Mike: That’s right, though this is the latest version of Exodus’ business. The company started out simply providing the computing power and letting the Web site managers take care of the rest. Now, more and more, Exodus provides what’s known as “lights out” services, where it manages everything for a fee--providing the hardware as needed and ensuring that it works.

And here’s the important point: Demand for the services Exodus and others offer is running far, far ahead of supply.

Jim: Which is another way of saying that the prospects for Exodus appear terrific. Based in Santa Clara, this outfit already has more than 3,700 customers. And in the nine months ended Sept. 30, Exodus’ sales more than tripled from a year earlier, to about $540 million. And it’s expected to keep growing even though many “dot-com” companies are going under.

Mike: That’s true. The online Web-hosting industry is much larger than the dot-com companies we’ve seen proliferate and then march over the cliff in lock-step. Major corporations, small businesses and even individuals need these sorts of services.

Jim: Plus, Exodus is in the process of buying its biggest competitor, Global Center, from Global Crossing Ltd. for about $6.5 billion. That will give Exodus an even bigger lead in its market.

And finally, I like Exodus’ chief executive, one Ellen Hancock, who’s an interesting story in herself.

Mike: Yes, she has blazed quite a career path, having been squeezed out of management jobs at IBM, National Semiconductor and Apple Computer. That’s what prompted her to sign on with Exodus in 1998.

Jim: Hancock, who’s fiftysomething, is a shining example that perseverance pays off.

Mike: I do have one question about Exodus, though: Shouldn’t this company be profitable by now?

Jim: You took the words right out of my mouth. For as strong as its business is, Exodus isn’t expected to reach the black until 2002. That’s a big caveat when it comes to this stock. But I’d buy it anyway.

Mike: Me, too, mainly because of Exodus’ stock price, the decline of which has offset the risks in its near-term earnings outlook, in my view. Besides, I’ve said before that when it comes to the Internet, there’s wisdom in focusing more on the infrastructure rather than on the companies that connect with consumers.

Jim: I agree. Exodus’ stock has taken a beating since September, and it’s down 74% from its 52-week high. Much of that, I think, is because of the rout in technology shares generally.

And let’s face it: Investors right now aren’t wild about any Net-related company that doesn’t make money. But Exodus has got market dominance, good technology, strong management and great prospects, so the stock’s slump just makes for a better entry point for investors.

CheckFree (CKFR)

Jim: Don’t buy

Mike: Don’t buy

*

Mike: Up next is CheckFree Corp. and, in keeping with one of the themes today, this company also is profit-free.

Jim: Quite a coincidence that both our companies today are leaders in their markets and don’t yet make a dime.

Mike: But the comparisons stop there. I don’t know about you, but I’m more skeptical about CheckFree and its stock.

Jim: This is getting scary, because I agree with you again.

Mike: At any rate, CheckFree is basically a middleman that helps billers and bill payers handle online payments. In other words, if you are--just to pick a situation out of a hat--a user of Bank of America’s online bill service . . .

Jim: Which I happen to be.

Mike: As am I. Anyway, both of us can pay a lot of our bills online with our computers. You simply click on the Bank of America Web site, plug in a password, choose whose bill you want to pay and how much of it and let ‘er rip. CheckFree is the company that makes it happen.

Jim: And there’s another element to this process.

Mike: Right. Utility companies, mortgage companies and other big creditors want to post their bills to you online, rather than mail them to you on paper. CheckFree handles that, too.

Jim: So now CheckFree has more than 200 companies for which it handles online bills.

Mike: Is that a lot, or a little?

Jim: Seems like a lot to me.

Mike: It strikes me as a little.

Jim: Really? But it translates into something like 4 million people using CheckFree, even though they probably don’t realize it.

Mike: Swell, and there are 250 million people in the United States. And each one of us receives, what, 40 million bills a year?

Jim: Look, the point is that CheckFree--which had revenue of $310 million in its fiscal year ended June 30--dominates its business. As brokerage Morgan Stanley Dean Witter pointed out recently, CheckFree’s 4 million users compare with the 1 million or so customers of its other competitors combined.

Mike: But look closer at this business, namely at the up-and-coming competitors CheckFree is facing. For starters, there’s the Spectrum consortium, which includes such paltry little companies as Chase Manhattan, First Union and Wells Fargo. Gee, they’re not going to be formidable competitors, are they?

Jim: Your sarcasm is noted.

Mike: Thanks for the stage direction. Plus, out of the total number of people who are likely to use a service like this--say in the next five years--how many are using it already? I would say that percentage is very high. So the big challenge for companies like CheckFree is moving more people into the system. Until that happens, CheckFree makes only pennies, or even loses money, on every bill it handles.

Jim: Yeah, it bothers me that CheckFree dominates its business, that online bill paying has been evolving for several years, that home computers saturate this country--and yet CheckFree can’t turn a profit.

Mike: Then there’s a rather shocking number that I read in some of our research, and that’s the number of transactions that require CheckFree to get involved in resolving a billing dispute.

The disputed cases amount to about one-third of 1% of the total monthly payments that CheckFree handles. Now that may not sound high in percentage terms, but in absolute terms it comes to 61,000 claims a month. Some presumably result from CheckFree errors, some from mistakes at one end or the other. But that’s a lot of productivity, manpower and cash that CheckFree has to devote to fixing screw-ups.

Jim: We’re not the only ones with doubts about CheckFree, as its stock indicates. The shares, which outpaced the broader market in 1998 and 1999, have lost more than half their value this year and now trade in the low $50s.

But I still wouldn’t buy the stock today, because I just don’t have a lot of confidence about CheckFree’s prospects going forward.

Mike: I wouldn’t buy it, either, and the confidence issue is a good way of looking at the situation. A big leap for CheckFree would be if more people not only pay their bills online, but also get those bills online. But how confident in technology do people have to be to agree to that?

Unless you have, say, a broadband connection that leaves you always connected to the Internet--and most people don’t have that kind of connection--it seems highly unlikely that many people will give up paper mail notification of something as important as their bills.

*

Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). Either can also be reached at Business Section, 202 W. 1st St., Los Angeles, CA 90012.

You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).