Internap's colocation expansion - better late than never

Internap reported 4Q and full year results last night, on March 12.

Both IP and CDN services were down sequentially, and colocation was the only sector to show Q/Q growth (up 31% in 2008).

Internap CEO, Jim De Blasio, hosted his last conference call with the Company, as Eric Cooney will step in officially on March 16. This transition might also explain the reason why few analysts were on the call, and the Q&A section was quite brief - as Jim said, opening the call, this was not the appropriate time to discuss Internap's future business strategies, given the change in leadership.

Internap 4Q 2008 conference call transcripts are available at Seeking Alpha.

While we are not going to dig into 4Q results, the purpose of this brief article is simply to review Internap's strategy, and execution, in the colocation side of its business, looking beyond the strong growth achieved (in line, however, with that specific market). We believe that Internap did lose, during 2008, the opportunity to bring on line more colocation space, and increase its results and market share in this business segment.

On June 12, 2007 Internap announced its intention to invest in expanded colocation facilities:

• Internap Network Services Corporation (NASDAQ: INAP), a global provider of optimized, reliable end-to end Internet business solutions, today announced that it has approved an investment of up to 40 million dollars to fund the expansion of its colocation facilities in several key markets. The company anticipates implementing the expansion over the next three to four calendar quarters, with any potential funding to be provided under standard commercial financing arrangements.

The implementation of this strategy took, in our opinion, slightly longer than originally planned.

First of all, it has to be remembered that Internap utilizes both partner and own data centers, and this expansion was meant to increase the footprint in its own locations, where margins are much higher - this is taken from Internap's 3Q conference call, available at Seeking Alpha:

• George Kilguss (Internap's CFO)

• Data center gross margins should increase as utilization rates increase in our company-controlled occupied space contributes to revenue.

• Jim DeBlasio (Internap CEO)

• Yes. I think the business model that would be preferred would be to build our own and fill our own due to the higher margins we would get on that. And where it’s driven by our customers, that’s the margins are strong in partner size, we would take down space in partner sites as well. But the first preference would be to build and sell our own.

We already noticed in a previous article back in August 2008 that the lack of space available in Internap's own centers did penalize the Company form a margin point of view - these quotes are taken from Internap's 10Q:

• The increased use of partner sites is one reason for the higher percentage of direct costs for the three-month period ended June 30, 2008 compared to the same period in 2007. We continue to expand the sites operated by us and expect to have more of this space available to be used in the future as part of our data center growth initiative.
• We seek to optimize the most profitable mix of available data center space operated by us and our partners.
• We expect our recent data center expansion will provide us lower costs per occupied square foot in future periods, enabling us to increase revenues compared to relatively lower direct costs of data center services.
• The initial operating costs, especially for rent, of sites operated by us causes us to recognize some costs ahead of revenues but overall is more profitable at minimum levels of utilization than the use of partner sites.

This picture is taken from an Internap's presentation, and we had added, in red, a few comments related to the expansion plans back in August 2008:


We had already noticed that these expansions would mainly impact results at the end of 2008 and in 2009, however, the opening of the last centers (Boston and New York) was slightly delayed from this updated plan, too, and we should probably say that the majority of room has only become available in 2009 - here is a short summary of the openings:

Seattle opened in the 2Q 2008 - 3 full quarters after the initial announcement;

Houston in the mid of 3Q 2008 - 4 full quarters and a half after the June 2007 P/R;

Boston opened in the 1Q 2009 (officially on February 5) - 6 full quarters after the June 2007 P/R;

New York is now said to be ready for opening next week, at the end of the 1Q 2009 - almost 7 full quarters after the June 2007 P/R - this quote is from the 4Q 2008 conference call (emphasis added):

• George Kilguss

• In our datacenter business, we opened 22,000 square feet of partner sites and 17,000 square feet of owned properties in 2008. In early January of this year, we completed construction of the expansion in our company-controlled Boston and New York datacenters. In our 15,000 square feet Boston expansion to begin turning up customers in early January and we are seeing consistent demand there. In New York, the 8,000 square feet expansion will open for customers next week. With the turn up of New York, the Company completed 3,000 square feet expansion of enterprise tier company-controlled datacenter space in four cities.

While Internap is now positioned to benefit from the strong data center demand in the market, and increase margins in this segment, we believe that execution hasn't been stellar and the Company has missed an opportunity to benefit from the positive colocation momentum in 2008.