DIGEX IPO Plans Stir Debate

An Internet service provider aims to buck the consolidation wave and silence its critics

The T-shirt and jeans days are over at DIGEX. The suits have arrived, and major climate and cultural changes are now underway at the fast-growing local Internet service provider, which began doing business six years ago inside the basement of its founder's home.

The Beltsville, Md., company's management, which recently announced plans to go public, claims it has a grand plan that will enable it to become the largest independent Internet service provider in the world.

"UUNET is not UUNET anymore and PSINet will most likely be sold. We're the Switzerland of [Internet service providers]," said DIGEX Chairman and CEO Chris McCleary, who believes the company will be able to defy the industry's consolidation trend and remain independent.

To meet that goal, DIGEX is planning to raise $55 million from an initial public offering expected some time before year-end. Saloman Brothers Inc. and Montgomery Securities are underwriting the offering.

"We're one of the few Internet companies that has done a good job of integrating the Internet pioneers with some telecom managers and telecom experts from the outside," said McCleary.

But with 3,000 Internet service providers in the United States and a five-year forecast that predicts 80 to 90 percent of them will no longer be in business, the future of DIGEX seems as uncertain as its competitors'.

"Going public right now is not the best thing for Internet companies," said Eric Pollack, a research analyst with Gartner Group. "The Internet thrill on Wall Street has died down. DIGEX will not raise the money [from its public offering] that UUNET and PSINet did."

Pollack is referring to recent fluctuations in Internet stock in the last six months. For example, PSINet's stock price has had $50 fluctuations since its public offering last year.

Pollack said a small company such as DIGEX will have a hard time surviving against the likes of UUNET and AT&T without being acquired or merging. He predicts LCI, the sixth largest telecom company in the United States, will help DIGEX and possibly acquire it.

John Sidgmore, founder, president and CEO of UUNET, whose company's initial public offering was worth $66.15 million and recently merged with MFS Communications, agrees with Pollack.

"It will be a rough fight for DIGEX. The company is years behind the national players," said Sidgmore. "DIGEX is a small player in a market where millions are being poured into it."

The story behind DIGEX is a familiar one. The company was founded by Internet pioneers Doug Humphrey and Michael Doughney in 1990. Humphrey, who was 30 years old when he started DIGEX, was a senior TCP/IP networking and computer security specialist for Tandem Computers Inc. and was president and CEO of Computer Time Share Corp. Doughney, who was 31 at DIGEX's launch, had a degree in computer science and electrical engineering from the University of Maryland.

The company was started in Humphrey's basement in Greenbelt, Md., as a local provider of dial-up Internet connectivity. The company, originally called Digital Express Group Inc., grew quickly, reaching $431,098 in 1993. The company expanded to another building in Greenbelt, which was shared by a Chinese restaurant.

The majority of DIGEX's customer base came from household consumers and telecommuters. In March 1995, when the company hit $5 million, the young entrepreneurs sought institutional equity capital in an effort to refocus the company by offering "industrial strength" Internet access to attract corporate accounts and begin to develop a World Wide Web server hosting business. Company revenues have grown 222 percent from $1.6 million in 1994 to $5.1 million. According to International Data Corp., Framingham, Mass., about 71 percent, or 40 million, of the approximately 56 million Internet users in 1995 were business-related users.

As the company experienced such quick growth, it relocated to a corporate park in Beltsville, Md., and solicited outside help to push the company further. Chris McCleary was recruited from American Mobile Satellite Corp. last February to serve as president, CEO and chairman of the board to take the company public, expand its local access to national Internet access and organize the company into four divisions. These divisions include Internet access to business-to-business customers, Web host servers, a telecommute service for small home offices and a private network group division.

The company has grown from 65 accounts to 750 accounts since April 1995. Its nationwide network infrastructure serves 24 U.S. cities through 30 points of presence, and its number of employees has grown from 30 to 160. But McCleary has greater expansion plans.

The company is targeting telecommunications service providers, which will provide private label Internet services to customers without building their own facilities. The company recently entered into two multiyear private network agreements with LCI and WinStar.

McCleary has changed the climate and culture of DIGEX. He has established a new management team with more of a business edge. The team includes three high-level executives from his previous employer AMSC, as well as Clyde Heintzelman from Bell Atlantic, Thomas Brandt from Price Waterhouse LLP, William Pendley from IBM Federal Systems and John Welling from KPMG Peat Marwick LLP. And he's planning to hire 50 more people by year-end.

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