PSINetThe fiber-optic communications firm PSINet went public
in 1995 and raised $46 million. Shortly thereafter, PSINet
began to serve business customers as well, establishing
100,000 business accounts in 27 countries. They undertook
a strategy to run one of the world’s largest networks,
linked to a massive number of PSINet-owned Web-hosting
centers. During this time, PSINet’s debt load increased 36-fold,
from $112 million to $4 billion. Its annual interest obligations went
from being $5 million in 1997 to being $400 million
in 2000. In April 1998, for the first time in its history,
PSINet issued debt that was below investment grade (junk),
selling $600 million in bonds paying 10 percent. The firm then made a series of large investments: It
spent $34 million for new headquarters, purchased a corporate
jet, and agreed to pay $90 million in order to have
the new Baltimore Ravens football stadium bear its name. The cover story in the May 28, 2001, issue of Forbes magazine describes how PSINet’s CEO, William
Schrader, and its board of directors assessed the firm’s
financing strategy. “We knew we were going to be heavy on the debt side,
light on the equity side,” says William Baumer, a board
member and an economist who heads the University of
Buffalo’s philosophy department. “The assessment was
that the debt markets are wide open, the equity markets not
as good, and if we are successful here, we won’t have any
trouble retiring this debt.” Schrader insists Wall Street
would have been cool to additional stock offerings, despite
PSINet’s lofty price. “Wall Street says when you can raise
equity,” he claims. In the two years leading to the peak of the technology
bubble in March 2000, PSINet’s stock price rose from
$7 to $60. Between 1997 and 2000, PSINet made 76 acquisitions. After a period of very rapid growth in the second half
of the 1990s, the telecommunications sector began a sharp
decline in the autumn of 2000. On May 1, 2001, PSInet
began to default on its $400 billion debt. It missed a
$20 million interest payment and announced that it would
likely seek bankruptcy protection. Its stock fell to 18 cents
a share and was delisted. PSINet’s CEO and founder,William Schrader, resigned
in May 2001. The Forbes story contains an interesting
description of Schrader, stating that “implacable self-confidence
helped Bill Schrader transform a few leased
phone lines into a sprawling global network.” Case Analysis Questions- Was the main factor driving PSINet’s capital structure
(a) the tradeoff between tax shields and costs of financial
distress, (b) asymmetric information, (c) its cash
position, or (d) perceived mispricing?
- Did PSINet’s managers use a financing pecking order?
- Did PSINet’s cash position affect its investment policy?
- Was PSINet’s chief executive officer overconfident, and
did he believe that PSINet’s equity was undervalued?
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