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Churn Rate Fuels Interland's Slide, Analyst Says

Richard Fetyko, a research analyst at investment bank Kaufman Bros., New York, pegged Interland Inc.'s recent stock slide to a basic problem: a churn rate that is eating away at its customer base.

Interland, Atlanta, which provides Web hosting and online services for small and medium-sized businesses, was downgraded by Kaufman Bros. from buy to hold Sept. 18.

The move came during a month in which the company's stock price fell 27.18 percent, from $10.56 on Sept. 2 to $7.69 on Sept. 30. It had made a run above the $10 level from $7.25 on Aug. 18.

“Prior to September there were expectations that the company's business would grow organically at a rapid pace,” Fetyko said. “It has grown through acquisitions in the last three years.”

Fetyko added that seven acquisitions have occurred.

“That's how they've built their business until recently,” he said. “They've got the critical mass, but organically, they're not growing. The churn in their customer base is too high. They're adding customers and losing them, but they're losing more than they're adding.”

On June 26 the company announced that during its fiscal third quarter ended May 31, it posted revenue of $25.9 million, up 4.77 percent over the third quarter in the prior year. However, the net loss from continuing operations totaled $136.8 million.

When asked about the reasons for the downgrade, Fetyko cited the “persistent churn, and the organic growth initiatives they've talked about were too aggressive in terms of timing. These growth initiatives looked solid on paper and looked like they should work. But it will take longer for them to gain traction.”

Since the beginning of March, the company has:

· Migrated customers, hardware and staff out of five data center facilities, bringing operational square footage to 27,000 square feet from more than 60,000.

· Moved more than 3,800 servers to core data centers in Atlanta and Miami.

· Reduced employees from 1,550 to 701.

“They have 190,000 shared hosting accounts and about 7,500 dedicated hosting accounts after the acquisition of Hostcentric that closed in July,” Fetyko said. “It looks like it could be another 12 months before we see net positive subscriber adds.”

Despite recent events, the analyst likes the firm's long-term prospects.

“The macro trends are positive in terms of more small and medium-size enterprises adopting the Web in terms of marketing their services,” he said.

The company cites on its Web site Yankee Group estimates of more than 20 million small businesses and home offices in the United States, “and the vast majority of them do not have a professional or effective Web presence.”

Fetyko said, “the opportunities are still huge,” and added that Interland during the next 12 months “is still a transitional story” as it moves from acquisition growth to organic growth.

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