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.

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.

Could CenturyLink’s Qwest buy prevent a future cloud infrastructure play?

Contact: Ben Kolada

Almost exactly one year after they announced their intention to merge, CenturyLink and Qwest Communications are set to close the largest US wireline consolidation play in the past half decade. But while the deal will more than double CenturyLink’s revenue, the debt assumed could prevent it from making another significant acquisition anytime soon. And that’s a shame, since the combined company’s datacenter business could use a boost.

Even in retrospect, the Qwest purchase is still a smart deal, since CenturyLink needs Qwest to expand its own meager business services division – especially since the telecom industry’s focus between consumer and businesses is increasingly leaning toward the latter. But while the move grows CenturyLink’s revenue, in the near term the assumption of Qwest’s debt will actually prevent the company from moving into the datacenter and hosting industry, which is showing more long-term potential than wireline services.

Neither Qwest nor CenturyLink are providing aggregate financial projections for 2011, but numbers from 2010 show the combined company will be weighed down by a hefty amount of debt. 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 mountain of debt 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 history, thereby forcing the company to focus on organic growth.

And this comes at a time when telcos are increasingly seeking growth by buying into the cloud infrastructure industry. With Qwest’s debt, CenturyLink may be the last to the table to acquire a large hosting provider, even though the company certainly needs one. Qwest’s datacenter footprint is already fairly small when compared to the other Regional Bell Operating Companies. In its last-ever annual report, the company cited 17 hosting centers in operation – that’s the same amount as many of the medium-sized private providers. Without an inorganic boost, the company could lose out on cloud infrastructure market share. Consider this: Qwest doesn’t break out datacenter revenue, but the business division’s sub-segment that includes this service only grew 8% in 2010. For comparison, in its 2011 Global Managed Hosting Market Overview, our Tier1 Research subsidiary predicted that the managed hosting sector’s global revenue will grow 19.8% this year.