Author: Ben Kolada

Is Earthlink looking to link up to a hosting company?

Ben Kolada

Contact: Ben Kolada

Earthlink on Monday said that it is acquiring regional competitive local exchange carrier (CLEC) One Communications for $85m in cash or stock, plus the assumption of $285m in debt. The deal is Earthlink’s second telecom play of the year, and from our view, it looks like the beginning of a strategy that’s already playing out at Windstream Communications.

The One Communications announcement came just three weeks after Earthlink closed the purchase of southeastern US CLEC ITC Deltacom. Both One Communications and ITC Deltacom are fairly large, as regional CLECs go. ITC Deltacom generated $451m in revenue in the four quarters before its sale, and we understand that One Communications came in at $575m in trailing sales. However, both companies’ sales were declining, and we suspect that the deals were primarily done to build out Earthlink’s facilities-based presence and lay the ground for an eventual hosting play.

If that’s correct, then the ISP will be setting itself on a similar track to the one laid by Windstream Communications. The Little Rock, Arkansas-based company picked up six telecom service providers before announcing last month that it was buying hosting provider Hosted Solutions. At least three other telcos have scooped up hosting companies just in the past two months. The reason for the shopping spree is pretty simple if we consider the relative growth rates of the two sectors: While the core telecom market continues to decline, hosters are putting up fairly solid growth – and that should continue. In their 2010 ‘Multi-Tenant Datacenter North American Market Overview’, our colleagues at Tier1 Research project that the sector’s total North American revenue will hit $11.1bn in 2013, up from an estimated $6.8bn this year.

Select recent telecom-hosting transactions

Date announced Acquirer Target Deal value
December 15, 2010 Telephone and Data Systems TEAM Technologies $47m
November 22, 2010 Sidera Networks Cross Connect Solutions Not disclosed
November 4, 2010 Windstream Communications Hosted Solutions [ABRY Partners] $310m
November 3, 2010 Cbeyond MaximumASP (assets) $31m
May 12, 2010 Cincinnati Bell CyrusOne [ABRY Partners] $525m
March 22, 2010 TDS Telecommunications VISI $18m
January 25, 2010 Cavalier Telephone NET Telcos (assets) Not disclosed

Source: The 451 M&A KnowledgeBase

Defense goes on offense

Ben Kolada

Contact: Ben Kolada

Constraints in federal defense spending are causing traditional defense contractors to look outside their core for growth. The latest move is Raytheon’s pickup of cyber security firm Applied Signal Technology. The $490m acquisition, announced today, wraps up a two-month process from when Applied Signal announced that it would seek ‘strategic alternatives’ to increase shareholder value.

Raytheon’s $38-per-share offer for Applied Signal represents a 37% premium over Applied Signal’s closing share price the day before it announced it was looking to boost its share price. We suspect the high valuation was partly the result of a competitive bidding process that included Raytheon competitors L-3 Communications and Cobham. However, this isn’t the first competitive process we’ve seen for a defense-focused IT service provider. The Applied Signal transaction comes just half a year after its larger rival, Argon ST, was scooped up by Boeing. We understand the Argon property was the focus of an even more hotly contested process, with Boeing eventually paying a premium of 41% above Argon’s share price the day before the deal was announced.

The rise in defense IT valuations is the result of traditional defense contractors looking for growth channels as the federal spigot tightens. After a dozen years of consistent growth in federal defense spending, the Office of Management and Budget projects defense expenditures will decrease by an aggregate of 5% from 2010-2015. Meanwhile, spending on IT defense is expected to rise. As a result, firms like Argon and Applied Signal have received healthy valuations, but they are not alone. Since late October, when Applied Signal announced it was looking at strategic alternatives to increase shareholder value, including selling itself, acquisition speculation has spilled over to Mercury Computer Systems, a maker of hardware and software systems for the defense industry. Since Applied’s announcement, shares of Mercury Computer have risen 40%.

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

Ben Kolada

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

Google adds to NFC with Zetawire

Ben Kolada2 Comments

Contact: Jarrett Streebin, Ben Kolada, Vishal Jain

Google continues to gobble up startups, and we’ve just uncovered a deal that supports its near field communications (NFC) ambitions. We’ve learned that Google recently picked up Zetawire, a Canadian startup focusing on mobile payments transactions. Like most of Google’s buys, this was a small deal, but it plays into a bigger market.

Little is known about Toronto-based Zetawire, but we suspect that the company was in the pre-revenue stage, making its only valuable asset a patent and corresponding trademark awarded by the US Patent and Trademark office. According to the filing, the patent provides for mobile banking, advertising, identity management, credit card and mobile coupon transaction processing. These features would allow a consumer to make purchases using their smartphone instead of their credit card. Think of a smartphone with this technology as a virtual wallet (in fact, the company has also trademarked the name Walleto for these very purposes).

This acquisition bolsters Google’s position in the coming wave of NFC and the phone as a device for payments, tracking and identification. For Google, the timing of the deal couldn’t have been better. Although we understand that the transaction closed in August, just earlier this month Google released its Nexus S smartphone, which has built-in NFC capabilities. In the meantime, Google’s competitors are hard at work. Research in Motion has also filed a patent for NFC functions, and Nokia in June announced that all of its phones will have NFC capabilities by 2011. Isis, a partnership involving telcos AT&T, T-Mobile and Verizon, is also planning a similar mobile wallet and UK startup Proxama has been working on NFC-focused technology for payments and advertising. (We’ll take a deeper look at the Zetawire purchase and the greater NFC market in an upcoming Post-Merger IQ.)

Windstream makes hosting splash among private equity waves

Ben Kolada

Contact: Ben Kolada

Windstream Communications bought into business services once again, this time picking up managed hosting, colocation and cloud computing provider Hosted Solutions. The deal is the first hosting play for Windstream, and shows that private equity buyers aren’t the only ones shopping in the sector.

Windstream is paying $310m in cash for Hosted Solutions, which posted $52m in trailing sales. The deal values Hosted Solutions at 12.7x its trailing EBITDA, and more than double the price that ABRY Partners paid for the company in April 2008. Hosted Solutions employs 125, and Windstream initially plans to retain the majority of those employees, though we expect there will be some corporate turnover as part of the integration.

Although telcos have gone shopping for colocation and hosting companies this year (with the most notable deal being CyrusOne’s sale to Cincinnati Bell), private equity firms have dominated the headlines. We recorded 10 hosting and colocation deals this year with deal values of at least $100m. Of this group, half of the targets went to private equity buyers, and four of those deals involved the target company simply jumping from one PE portfolio to another. Further, buyout shops, including firms both in the US and abroad, accounted for nearly half (46%) of the total spending for these 10 deals.

Top 10 hosting and colocation deals of 2010

Buyer category Number of acquisitions Percent of total spending
Private equity 5 46%
Hosting/colocation 3 32%
Telecommunications 2 22%
Total spending $3.8bn

Source: The 451 M&A KnowledgeBase

Take two for SunGard Availability Services

Ben Kolada

Contact: Ben Kolada

SunGard recently disclosed that it is taking a second look at divesting its Availability Services (AS) division. The company first attempted to shed the AS segment in 2004, but the move was canceled when SunGard was acquired by a consortium of private equity firms. The unit contributes slightly more than one-quarter of SunGard’s total revenue, and, like the rest of SunGard’s business lines, has seen a decline in sales. However, the AS division has proven more resilient than the remainder of SunGard’s businesses; the revenue of those three units combined has dropped nearly 8% in the first nine months of this year, compared to the same period last year.

Meanwhile, sales at the company’s AS division fell only about 3%, due in part to declining demand for disaster recovery (DR) services. If cut free, we expect that the independent SunGard AS could focus on and invest in its managed hosting, cloud and colocation businesses, which, over time, would more than offset losses from its traditional DR services. In particular, the division’s managed hosting services have considerable room to grow, as we project that global revenue for that segment will increase 20.8% in 2011.

SunGard AS is already investing in cloud and managed hosting services, as well as refining its geographic focus. We recently wrote about the division extending the capability of its cloud computing platform to provide an enterprise cloud service, and noted the appointment of Andrew Stern, former CEO of managed hosting provider USi, to its chief executive seat. As part of its geographic realignment, the company sold its South African operations two years ago and acquired Irish managed hosting provider Hosting 365 this past March.

No celebration for this anniversary

Ben Kolada

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.

To scale or not to scale

Ben Kolada

Contact: Ben Kolada, Brenon Daly

For businesses that both had ‘scale’ in their name, neither MaxiScale nor ParaScale got very big. Nor did they get very big exits in their recent sales. In the crowded cloud storage market – dominated by multibillion-dollar incumbents IBM, EMC and HP – startups have only a short time to prove themselves to potential customers. We suspect that both MaxiScale and ParaScale shared similar fates because VCs are becoming quicker to pull the plug on storage investments that aren’t lining up customers.

That’s particularly true for MaxiScale, which we covered a year ago as it emerged from stealth. While ParaScale chalked up some customer wins, rumors have it that MaxiScale was unable to actually generate any revenue from its product. The bleak outlook forced the company to sell its assets last week to Overland Storage at what we expect was a fraction of the $25m that investors poured into the firm. We doubt that Overland paid much more than $5m for the acquired MaxiScale assets.

However, not all cloud storage startups are landing on the scrap heap. While MaxiScale and ParaScale were unable to secure lifeline funding, rival Caringo raised a fresh $5m round in July. In the past year, the company claims to have increased its customer count from 150 to more than 400, and is set on reaching profitability by the first half of next year. We don’t consider the firm an acquisition target just yet, but if it continues to do well, it could draw some interest down the road.

Internet infrastructure in Q3: a dip in deal volume

Ben Kolada

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

For CLECs, valuations flatline

Ben Kolada

Contact: Ben Kolada

As the retail wireline communications industry loses steam, valuations for competitive local exchange carriers (CLECs) have flatlined. Regardless of whether or not the firms were growing their bottom line, CLECs are being sold at just north of one times trailing revenue. We don’t see much that would change this metric.

EarthLink’s recent purchase of ITC DeltaCom is the third instance in the past year in which a regional CLEC was acquired by a larger provider. The deal was announced shortly after PAETEC picked up Cavalier Telephone and just under a year after Windstream Communications bought NuVox Communications. Of these three providers, we believe only NuVox was growing its revenue, while Cavalier was experiencing losses and ITC DeltaCom was lying stagnant.

Yet all three firms were valued nearly the same. EarthLink’s offer for ITC DeltaCom values the Huntsville, Alabama-based company at just 1.1x trailing sales, including debt, while both Cavalier and NuVox went for 1.2x. (As a side note, we would add that both Cavalier and NuVox were owned by M/C Venture Partners.)

We wouldn’t be surprised to see other similarly sized CLECs – such as Cbeyond, TelePacific Communications or Integra Telecom – fetch roughly the same valuation in any sale. For example, take Cbeyond, which is similar in size to ITC DeltaCom. The firm is currently priced at 0.9x trailing sales, nearly mirroring the 0.8x valuation ITC DeltaCom had in the day before EarthLink announced that it was buying the company.

Recent CLEC valuations

Date announced Acquirer Target Enterprise value EV-TTM sales multiple
October 1, 2010 EarthLink ITC DeltaCom $516m 1.1
September 13, 2010 PAETEC Cavalier Telephone $460m 1.2*
November 3, 2009 Windstream Communications NuVox Communications $664m 1.2

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