Internap Needs to Figure Out What Business It's In

Internap (INAP) reported yesterday that quarterly revenues had declined 6% year-over-year to $61 million. The drop was expected as the company is trying to transform itself from a reseller of other provider's assets to a facilities-based data center provider. As part of that initiative, it has committed to a $50 million capital program.

Financially, Internap looks like the anti-Level 3 (LVLT). It shares Level 3's broad product line, but historically it has taken a hit on its income statement for reselling services at low margins, while Level 3 has taken a hit on its balance sheet by building large networks. Internap has much lower debt/revenue and much higher revenue/PP&E than Level 3 as a result. But now Level 3 is cutting capex to shore up its balance sheet, while Internap is increasing capex to improve its income statement.

Internap has never been a typical reseller. It developed a proprietary algorithm for routing traffic across multiple networks, but then extended the marketing concept behind this strategy to become a reseller of a broad range of IP and hosting services. Not unlike most resellers, it has a fairly broad product catalog. But transforming itself to more of a facilities-based provider means more than building up the capital budget, because it will not get a reasonable return on assets as without growing market share substantially.

Offering IP services, colocation, managed hosting, and CDNs. Internap is like Level 3, Equinix (EQIX), Rackspace (RAX), and Akamai (AKAM) rolled into one company, but without the market leadership in any of these services. To date, this has made it a balance sheet strong, but income statement weak distributor of other company's assets. But as it now builds on its own, it has to do more than commit capital to data centers, it has to look at where it can develop some kind of cost advantage over its competitors, and that won't happen in all four services.

Unlike its larger competitors, Internap owns proprietary routing software - MIRO (Managed Internet Route Optimizer) - that tackles many of the latency problems associated with BGP. But there is no reason to limit this technology to just its own service. If makes more sense economically to spread MIRO's development costs to other companies by selling it to them directly, not as part of a monthly IP service where the market has demonstrated it will not pay much premium for a proprietary technology.

In the collocation market, Internap has long relied on locating at existing facilities built by companies like Equinix and Switch and Data (which is now part of Equinix). But as long as its selling IP services, it will never truly be carrier neutral, which has been a key selling point for Equinix's service. Moreover, a $50 million boost in capital investment is not going to be enough to match the billions Equinix and Telx have already invested. It will likely have to compete on price, which is unpleasant if you are reselling, but deadly if you're selling access to your own assets.

Instead of competing against Akamai, Equinix, and Rackspace, Internap really should be competing against someone like privately-held Packet Design, which is selling its proprietary routing software to large carriers and enterprises alike. Routing is still an expensive, high latency, but necessary long distance network function, and Packet Design has had success solving corporate customers pain points with Cisco's proprietary EIGRP, and carriers' challenges with BGP. I know Internap is not about to shut down its network and just start selling its software, but there is a unique technology sitting within the company that is being stifled by the requirement that no one else can have access to it.

Yahoo's New Upstate NY Data Center Set to Open In September

Yahoo's (YHOO) new data center, located 20 miles north of Buffalo in Lockport, NY, is set to open this fall. The facility is part of Yahoo's save-the-world environmental strategy, which includes cutting its carbon intensity by 40%. And where better to do that in Western New York, which has a cool climate and inexpensive hydro power, not unlike the Pacific Northwest where Yahoo and other large Internet firms have built stand-alone centers. Yahoo claims its newest data center will have a PUE of 1.08.

This Yahoo center reinforces the trend of stand-alones locating near cheap power, while public data centers remain near abundant fiber optics. It's not unlike the trend that emerged 30-35 years ago with corporate office parks, where many of the single tenant facilities were built in suburbs to be near employees, while multi-tenant buildings stayed closer to downtown to be near transit lines, financial exchanges, or government buildings.

One factor sustaining this trend with data centers is continued advancement in WAN Acceleration technologies to haul traffic out of these facilities. WAN Acceleration used to be focused primarily on TCP windows and HTTP, but new services like Internap's (INAP) XIP, have targeted BGP-caused delays as well. In addition to new public services, stand-alone owners like Google (GOOG) have been drawing on advances in managing long-haul bandwidth from research networks like Intenet2 and ESnet.

In addition to benefiting from new cooling and bandwidth management technologies, this facility will be one of the first large stand-alones in upstate New York. With that region having many of the same climate and renewable energy benefits of Washington and Oregon, it could attract similar stand-alone facilities over the next five years, just as the Pacific Northwest has over the last five.

Data Center Providers Hit Particularly Hard in Selloff

NASDAQ was down 3.85% today, but data center providers did even worse.   Some of the big decliners today included:

• Equinix (EQIX) down 4.66%
• Savvis (SVVS) down 5.33%
• Rackspace (RAX) down 5.33%
• Internap (INAP) down 8.97%
• Akamai (AKAM) down 8.59%
• Terramark (TRMK) down 5.99%

One company bucking today's trend was CDN provider Limelight Networks (LLNW), which finished up 3 cents.