Telcos playing a new hosting game

Contact: Ben Kolada

Datacenter operator Digital Realty Trust on Wednesday announced that it paid $80m for a three-property portfolio of datacenters from French telco Bouygues Telecom. The deal could signal yet another robust year in Internet infrastructure M&A, but also shows that telcos are playing different strategic cards in the ongoing hosting game.

Last year set a record in Internet infrastructure M&A deal volume with 110 acquisitions announced, according to The 451 M&A KnowledgeBase. The record is particularly notable as it comes at a time when telcos are weighing alternative options to acquiring hosting properties. With the exception of NTT Communications, which announced three hosting acquisitions last year, telcos have largely been out of the M&A arena.

In fact, as evidenced by Bouygues’ divestiture, telcos are now considering strategies other than buying or owning high-growth hosting businesses. For example, the Digital Realty-Bouygues deal is structured as a sale-leaseback transaction, in which datacenter specialist Digital Realty will own the facilities but Bouygues will lease and operate them. Other telcos, such as Cincinnati Bell, have also decided to pass their hosting facilities on to vendors more versed in the business. Cincinnati Bell is spinning off its CyrusOne hosting unit into a publicly traded entity. CyrusOne will debut on the Nasdaq tomorrow, planning to sell 16.5 million shares $16-18 each.

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Continued M&A activity in hosting sector expected in 2011

Contact: Ben Kolada, Aleetalynn Schenesky-Stronge

The past year set several records for M&A in the hosting and managed services sectors. Industry players, including fellow companies, private equity (PE) firms and telecom carriers, announced a total of 102 deals, eclipsing the previous record set in 2006. The aggregate value of last year’s transactions hit $4.8bn. True, records set in 2010 were partially the result of pent-up demand from the Credit Crisis, but we wouldn’t call the year a fluke. In fact, we expect that 2011 will continue the upward trajectory.

In 2010, we saw record acquisitions of all flavors. In terms of deal size, at an estimated $450m, SoftLayer Technologies’ sale to GI Partners and SoftLayer’s management topped our list of PE purchases of hosting providers. Buyout shops were also active internationally, with both Lloyds Banking Group and Montagu Private Equity each inking deals. Meanwhile, telecom providers were particularly active last year. Telco incumbent Cincinnati Bell announced the largest telecom-colocation transaction on record, and notable mention goes to Windstream Communications for its $310m pickup of Hosted Solutions. Meanwhile, wholesale datacenter provider Digital Realty Trust inked the sector’s largest acquisition of the year (in fact, the largest colocation transaction we’ve ever recorded), paying $725m for Rockwood Capital’s 365 Main portfolio.

On the macroeconomic side, we expect M&A in the hosting and managed services industries in 2011 to be driven by the following: enterprises converting capex to opex through IT outsourcing, increasing acceptance of outsourcing since that model successfully solved internal IT constraints; improving access to capital, allowing providers to continue to expand and innovate in order to meet market demands; and investment for growth, whether that be directly through M&A, via funding provided by PE, or both. On the microeconomic side, M&A will be predominately driven by consolidation and rollup to achieve scale, amass customer bases and add complementary infrastructure and service lines in order to create and expand new service offerings. Click here to see our full review of 2010 and our predictions for 2011.

Digital Realty’s M&A train will slow in 2011

Contact: Ben Kolada

Wholesale datacenter provider Digital Realty Trust has been on a buying spree this year, having spent more than 10 times what it shelled out in all of 2009. In total, the company has spent $1.3bn for acquired properties. The majority has come on just two transactions: Sentinel Data Centers and Rockwood Capital’s 365 Main portfolio. Although the deals are starting to pay off, we don’t expect that the firm will write such big checks in 2011.

With the newly acquired properties, Digital Realty’s sales have surged. The company’s revenue is projected to hit $867m this year, which would represent a 70% increase over 2009. Compare that to the more organic growth of 26% in 2009 over 2008. The 365 Main purchase, which closed in mid-July, catapulted third-quarter total revenue 45% over the previous year’s quarter.

However, deals the size of Sentinel Data Centers and 365 Main won’t happen again for some time. San Francisco-based Digital Realty says it will continue to buy properties in 2011, but expects to spend far less than it has this year. The firm says total spending on acquisitions in 2011 will likely be in the range of $200-450m. The midpoint of the range is about one-quarter what Digital Realty has spent so far on deals this year, but still north of the $220m it spent in 2009.

Select Digital Realty Trust acquisitions, 2010

Date announced Target Deal value
June 2 Rockwood Capital (365 Main portfolio) $725m
January 25 Sentinel Data Centers (New England portfolio) $375m

Source: The 451 M&A KnowledgeBase

No celebration for this anniversary

Contact: Ben Kolada

One year ago, Equinix announced that it was acquiring Switch and Data in its largest-ever transaction. The deal gave Equinix an immediate presence in several new markets, and alleviated capacity constraints in existing ones. However, the acquired properties haven’t lived up to their expectations, and Equinix was forced to trim its revenue guidance as a result. (Equinix will provide more details on its Q3 results on Tuesday.)

With the revision, investors sliced $1.3bn (about 25%) in market value from the combined company. For perspective, that’s nearly twice the amount that Equinix paid for its rival. And it’s not as if the Internet infrastructure industry is anti-acquisition. Digital Realty Trust closed two major deals this year worth a combined $1.1bn. Meanwhile, its shares have climbed 20% since the year began, compared to the Nasdaq’s 8% return.

With its hands full on its consolidation play and the market having punished its stock, Equinix won’t be announcing another acquisition anytime soon. In fact, we wonder if Equinix might not be a seller before it once again returns as a buyer. We wouldn’t be surprised to see the company divest legacy Switch and Data assets that are outside its core footprint.

Internet infrastructure in Q3: a dip in deal volume

Contact: Ben Kolada

In the just-closed quarter, we noticed a slight dip in the number of announced deals. In fact, the deal volume has continued its slide ever since the industry hit its peak in the first quarter of 2010. That’s not to say that our readers should make like Equinix’s investors and run for the exit. True, deal volume did slide downward, but the brand names of the Internet infrastructure industry continued to make long-term investments.

The total number of transactions announced in the third quarter declined 13.5% from the second quarter and 27.3% from the first quarter of the year. However, we must note that Q1 deal volume was, in fact, artificially inflated somewhat as some deals that were put on hold during the worst part of the recession in 2009 were finally closed in Q4 2009 and the beginning of 2010 due to renewed optimism in the economy and the ability to once again access capital at reasonable rates.

Overall, the number of transactions is up year over year, with Q3 2010 yielding 23% more transactions than the year-ago period. In fact, the total number of deals announced in the first three quarters of this year has already topped the full-year total for 2009. Furthermore, well-established names in the Internet infrastructure sector, including Digital Realty Trust, Limelight Networks and TeleCity on the industry side and GI Partners, Sequoia Capital and Welsh, Carson, Anderson & Stowe on the investment side, just to name a few, came to the table in the third quarter. We’ll take a deeper look at Q3 deal volume in a report that will be included in tonight’s Daily 451 sendout.

Recent quarterly deal flow

Period Number of transactions Percent change from previous quarter
Q1 2009 12
Q2 2009 17 42%
Q3 2009 26 53%
Q4 2009 28 8%
Q1 2010 44 57%
Q2 2010 38 -14%
Q3 2010 32 -16%

Source: The 451 M&A KnowledgeBase, Tier1 Research

Private equity goes back to the hosting table in a big way

Contact: Ben Kolada

So far this year, three private equity (PE) firms have each shelled out at least $400m for a hosting provider, making 2010 the most active year for big-ticket hosting deals for PE shops. And these firms are no novices. Welsh, Carson, Anderson & Stowe, GI Partners and Oak Hill Capital Partners have a combined $32bn in capital under management, and each has had previous experience in the hosting sector. The fact that they’re coming back to the hosting market – and paying relatively rich valuations to do so – is a hearty endorsement of the sector’s long-term growth potential.

In the most recent deal, Welsh Carson teamed up with Peak 10 management to buy the company from Seaport Capital and McCarthy Capital. Although terms of the transaction weren’t disclosed, we understand the buyout consortium paid just north of $400m for Peak 10, or about 12 times the company’s annualized 2010 EBITDA. For comparison, Savvis, in which Welsh has been invested since 1999, is currently trading at 5x annualized EBITDA.

In another management buyout, SoftLayer Technologies’ management announced in August that it was partnering with GI Partners to buy the dedicated hosting specialist from its angel investors. Again, terms weren’t disclosed, but we believe the deal valued SoftLayer at about 10x its annualized EBITDA, or about $450m. As my colleagues Philbert Shih and Aleetalynn Schenesky-Stronge noted, GI Partners is a well-known participant in the hosting and Internet infrastructure space, having invested in Digital Realty Trust and The Planet. GI Partners intends to combine The Planet and SoftLayer, with SoftLayer’s management left in charge. The combined company, which would have $270m in estimated revenue for 2010, could go public as early as next year.

SoftLayer was GI Partners’ second hosting play of the year. In April, the firm banded together with Oak Hill Capital and ViaWest’s management to buy the company from a consortium of PE investors. Oak Hill Capital was the lead investor, with GI Partners and management retaining minority stakes. We estimate the price of the deal at $420m, which works out to about 10x ViaWest’s cash flow. Oak Hill Capital isn’t new to the datacenter industry, having previously invested in TelecityGroup.

More PE moves could be in the works, as we’re aware of quite a few more properties for sale. If the flurry of M&A activity during the recent VMworld conference is any indication of what happens when a group of likeminded individuals gets together, our 2010 Hosting & Cloud Transformation Summit could lead to a number of hosting and Internet infrastructure deals. The conference opens today in Las Vegas and continues through Wednesday.

Select PE hosting deals in 2010

Date announced Acquirer Target Deal value
September 1 Welsh, Carson, Anderson & Stowe/Peak 10 management Peak 10 $400m*
August 4 GI Partners/SoftLayer Technologies management SoftLayer Technologies $450m*
April 20 Oak Hill Capital Partners/ViaWest management ViaWest $420m*

Source: The 451 M&A KnowledgeBase *451 Group estimate