Time is money

Contact: Ben Kolada

Novacap Technologies is selling Canadian hosting portfolio company iWeb Group to Internap Network Services for $145m, representing a quick – and solid – return for the Canadian private equity firm. Just two years ago, it took iWeb private for $69.6m (including the assumption of net debt).

Under Novacap, iWeb grew total revenue 50% while maintaining basically the same operating profit margin (only adjusted EBITDA was disclosed in iWeb’s sale to Internap). It also now serves 10,000 SMB customers in more than 100 countries. Though Novocap’s total ROI isn’t immediately clear, the firm undoubtedly did well on its two-year holding. Jefferies advised Internap, while Bank Street Group worked the sell-side.

On the flip side, for Internap, this deal highlights the interplay between two of the most important elements of any transaction: time and money. In this case, waiting longer to buy iWeb meant Internap ended up paying more for it, both on an absolute and relative basis. And Internap will end up paying for it longer: the company is taking on new debt to cover some of the cost of iWeb, which is twice as high as it was the last time the company was on the block.

iWeb’s rising valuation

Metric Sale to Novacap* Sale to Internap
Deal value $69.6m $145m
Price/sales 2.3x 3.3x
Price/EBITDA 9.3x 13.2x**

Source: The 451 M&A KnowledgeBase *Using enterprise value **Using adjusted EBITDA

Cut the CDN already, InterNap

Contact: Ben Kolada

We’ve long covered InterNap Network Services as both a potential target and a datacenter services vendor with disappointing earnings. With what’s likely to be another underwhelming quarter (the company reports Q3 results after the bell today), we take yet another look at what can be done to save this barely floating ship.

At this point, InterNap has got to unload some of its non-core assets. The company’s IP services segment, made up of interconnection and CDN services, is dragging on its total revenue (revenue from this segment fell 8% last year). However, interconnection is among the core services for hosting providers, so we’d suggest just divesting its CDN assets. Now may in fact be the best time to start weighing this option, given recent positive developments in the CDN sector. Akamai Technologies, the largest CDN provider, reported earnings yesterday that showed revenue grew 11% in Q3 from the year-ago period. And earlier this month, Japanese telco KDDI announced that it was taking an 86% equity stake in CDNetworks in a deal that gave the target an implied equity valuation of $195m. Even though growth had stalled at Seoul-based CDNetworks, the company was still able to command a 2x price-to-sales valuation (which stands in stark contrast to mostly disappointing valuations in the CDN sector).

Cutting some of the fat from InterNap’s business could make the company more palatable to prospective acquirers. However, the lack of growth is likely to prevent interest from most telcos. Instead, at this point buyout shops may be the most interested acquirers. Not only does InterNap have some of the characteristics PE firms prefer (it has very little net debt and consistently generates healthy cash flow), the company’s price is still within reach of some of the larger firms. Applying a simple 30%-per-share premium would put its price in the ballpark of $400m. For comparison, last year we saw financial firms announce a trio of deals each valued at $400m or more.

Windstream misses the message

Contact: Ben Kolada

As the telecom industry continues its buying spree, some firms are missing the bigger picture – hosting and datacenter services are the new growth channels for telcos. While CenturyLink and Verizon have each announced acquisitions in the growing datacenter services industry, Windstream Communications appears to be satisfied with consolidating telecom assets. The telco’s purchase of complementary competitive carrier PAETEC is its seventh telco rollup since its formation in 2006. And while PAETEC does provide a wealth of network assets, it contributes little in the way of revenue growth. For the price it’s paying for PAETEC, Windstream could have gobbled up a number of hosting properties at a fraction of the cost.

To be fair, Windstream’s PAETEC pickup does provide more than 50,000 high-revenue enterprise accounts and an expanded fiber footprint. But the target’s organic revenue has been flat in recent years, and growth this year is likely to come primarily as a result of the Cavalier Telephone buy it completed in late 2010. (We would also note that Cavalier’s revenue was in precipitous decline, due primarily to churn in its consumer division. Cavalier’s revenue dropped from $421m for full-year 2009 to an estimated $390m in trailing revenue at the time of its sale.)

Beyond fiber and enterprise accounts, Windstream is also interested in PAETEC’s datacenter services assets. And rightfully so, considering Windstream’s hosting assets could certainly use a boost. The company’s last pure M&A foray into the hosting sector was in November 2010, when it shelled out $310m for Hosted Solutions. That target only generated $51m in trailing sales, or about 1% of Windstream’s total revenue. But for the $2.2bn the telco is paying for PAETEC (including the assumption of debt), it could have easily expanded its hosting footprint in the US and abroad by acquiring both InterNap Network Services and Interxion. Applying a flat 20% equity premium to the pair would put their combined deal value at about $1.6bn on an enterprise value basis, or about three-quarters of PAETEC’s price.

InterNap’s time as a takeover target could be running out

Contact: Ben Kolada

If its past is any prediction of its future, hosting services provider InterNap Network Services could soon lose its position as the industry’s next takeover target. The Atlanta-based firm, which is set to release its second-quarter results, has seen flat sales for the past three years. This is in stark contrast to the hosting industry at large, which has historically grown in the double digits. Meanwhile, other firms are emerging as more desirable targets, pushing InterNap to the back of the buyout line.

Our colleagues at Tier1 Research have written that InterNap was a favored takeover target. However, the firm appears to have since lost its luster. Investors are becoming increasingly frustrated with its poor performance, particularly after first-quarter total revenue declined 6% year over year. And shareholders once again fear the worst – in the past month, shares of InterNap have lost more than one-tenth of their value.

As InterNap is lying stagnant, other firms are posting enviable growth rates, making them much more attractive acquisition candidates. We understand that privately held SoftLayer is gearing toward the public markets, though it could certainly be scooped up before filing its paperwork. SoftLayer surpassed InterNap’s revenue last year, and is projecting bottom-line growth of about 20% this year, to just shy of $350m. InterXion has been cited as a potential target, as well. The company is also enjoying double-digit growth rates, and would provide a large platform for any telco looking to expand its European hosting footprint.

We would note, however, that both InterXion and SoftLayer are considerably pricier properties. While InterNap currently sports a market cap of about $330m, InterXion is valued at nearly $1bn. And we estimate that SoftLayer, on its own, cost GI Partners some $450m. However, when including the other legs of the SoftLayer platform – Everyones Internet and The Planet – the full price to the buyout shop could exceed $600m. But InterXion’s and SoftLayer’s price tags won’t necessarily stand in the way of their sales. We would never have guessed that CenturyLink would have been able to afford Savvis, especially so soon after closing its $22bn Qwest purchase.

US telcos feeling the squeeze

Contact: Ben Kolada

Amid double-digit revenue growth in the cloud infrastructure market, US telcos are increasingly buying their way into this industry in an effort to stem losses in their traditional wireline businesses. However, just as the hosting and colocation sectors are growing rapidly, so too are the major players being acquired. So far this year, we’ve already seen three of the largest hosters scooped up by eager telco service providers, with CenturyLink’s $2.5bn Savvis purchase being the most recent. If the remaining telcos don’t move fast enough, they could increasingly be squeezed out of the growing cloud infrastructure space. And competition for the remaining firms is expected to increase as foreign operators could look to enter the US market as well.

Atlanta-based Internap Network Services is among the short list of firms most likely to be taken out next. The company has a wide-reaching geographic footprint, with facilities spread throughout the US, Europe, Asia and Australia. The company’s large US and international presence makes it a particularly attractive target, especially for large CLECs such as tw telecom and PAETEC, or even cable MSO Comcast. However, its footprint could also attract foreign operators looking for synergies in their home markets, as well as entry into the US market. My colleague Antonio Piraino at Tier1 Research recently penned a piece reminding buyout speculators that just a few years ago Internap rebuffed a takeover offer from Indian telco Reliance Communications. He notes that Reliance may once again be a potential suitor, alongside Asian firms Pacnet and China Telecom or European provider Colt Technology Services Group.

Though opportunities for US acquisitions are diminishing, domestic telcos still have options. Given the hyper-competitive takeover market that is expected for remaining US hosters, US telcos may instead look for international deals. As seen by regional stalwart Cincinnati Bell’s CyrusOne unit expanding into London, US telcos are showing no fear of international expansion when it comes to their hosting and colocation businesses. If US telcos look abroad, we wouldn’t be surprised if they checked out Interxion. The Schiphol-Rijk, Netherlands-based firm operates 28 datacenters in 11 countries spread throughout Europe, and pulled in more than €200m in revenue in 2010, a 21% jump from the previous year.

Hosters lose another telco acquirer

Contact: Ben Kolada

In the latest billion-dollar-plus telco transaction, Level 3 Communications has announced that it is acquiring Global Crossing in an all-stock deal worth $1.9bn. (The actual price of the acquisition – the largest we’ve recorded for Level 3 – is closer to $3bn when Global Crossing’s debt is included.) And while the deal impacts the telecom industry by bringing together two well-known fiber operators, in a way it more significantly impacts the hosting and colocation markets by removing yet another potential telco buyer. (We’ll have a full report on Level 3 buying Global Crossing in tonight’s Daily 451.)

Earlier rumors in the hosting and colocation industries had Level 3 as a potential acquirer, perhaps picking up CDN vendor Limelight Networks or hosting company Internap Network Services. These rumors were made more convincing by the growing trend of telcos buying into hosting and colocation. But in their conference call discussing the transaction, executives at Level 3 and Global Crossing put those rumors to rest, saying they don’t expect to announce another acquisition anytime soon. Further distancing Level 3 from the hosting M&A game is the fact that the company doesn’t appear to be too interested in hosting or datacenter services at all, since it chose a target that generates only 5% of its total revenue from these segments.

We previously noted that CenturyLink is likely out of the market as well, following its purchase of Qwest Communications for an enterprise value of $22.4bn, which saddled the company with a mountain of debt (the deal closed April 1). Last year, CenturyLink and Qwest held an aggregate $19bn in debt; that’s nearly equal to the revenue the two companies generated over the same period. Further, that debt load is more than five times the combined company’s free cash flow. Debt repayment obligations will likely put a halt to CenturyLink’s steady M&A activity, thereby forcing the company to focus on organic growth. With CenturyLink/Qwest and now Level 3 focused on integration, we expect that acquisition speculation following the next telco-hosting deal will be somewhat tempered.

Time Warner Cable picks up NaviSite; is InterNap next?

Contact: Ben Kolada

In the second telco-hosting rollup in less than a week, Time Warner Cable is acquiring NaviSite for $230m in cash. This is TWC’s first foray into enterprise hosting and cloud computing services, and marks the end of a tumultuous year for NaviSite that included defending itself from an unsolicited take-private and continuously retooling its business toward enterprise-class services.

TWC, the second-largest cable operator in the US, is paying $5.50 per share, representing a 33% premium over the closing price on February 1. Including the assumption of cash and debt, TWC’s offer gives NaviSite an enterprise value of $277m, or 2.1 times trailing sales and 10.8x trailing EBITDA. While the offer is roughly in line with broad market valuation, it is far below what Terremark received from Verizon. In that deal, announced just last Friday, the target was valued at 5.8x trailing sales and 24.7x trailing EBITDA. Of course, we might argue that Terremark deserves its premium, since it is much healthier and larger than NaviSite. Terremark has 16 datacenters (compared to NaviSite’s 10) spread across a large international footprint, a robust and growing cloud platform and more than twice the sales of NaviSite.

While NaviSite is set to be acquired at a lower valuation than Terremark, TWC’s bid represents a level NaviSite hasn’t seen on its own since late 2007. Further, it’s substantially above the offer that NaviSite attracted just a half-year ago. In July 2010, Atlantic Investors, which already owned one-third of NaviSite’s equity, made an unsolicited offer for the remaining shares of the company. Atlantic Investors’ bid of $3.05 per share valued NaviSite overall at $128m. Time showed that NaviSite was right in rejecting that offer, which isn’t always the case in these unsolicited bids. After spurning the offer, the company continued in its dogged determination to become an enterprise-class hosting provider throughout 2010 and divested some $74m in non-core assets to get there.

After NaviSite’s sale, speculation is intensifying about which hoster will be acquired next. We’ve written before that Savvis is an obvious target, and Rackspace is the constant focus of acquisition speculation. We might add Internap Network Services to that list. The Atlanta-based company’s shares are up 6% in mid-Wednesday trading, continuing a run since the Terremark announcement on January 27. One reason we might point to a trade sale for Internap is that the chief executive has done it before. In January 2009, the company appointed a new CEO, Eric Cooney, who has a history of growing companies and leading them to successful sales. He was previously CEO of Tandberg, which was acquired by Ericsson for $1.4bn in 2007. Since Cooney’s appointment, Internap’s shares have climbed 170%, giving the company a market cap of slightly more than $400m. Look for a full report on TWC’s pickup of NaviSite in tonight’s Daily 451.