hillary stiff - hostingcon july 2006, "mergers & acquisitions in the web hosting...

Mergers & Acquisitions in the Web Hosting Industry

Joe BardenheierEndurance International

Group, Inc.

Hillary StiffCheval Capital, Inc.

Agenda• Shameless self promotion of Cheval• Market conditions• Price vs. profits & risk• Deal structure highlights• Valuation • Summary

Cheval Capital, Inc.• Who we are.

– Boutique investment bank that began working in the industry with Verio in 1996.

– Completed 80 Hosting and ISP acquisitions, 18 in 2006.

• Who we work for.– Endurance International Group, Verio, Rackspace, Nextel, etc.– Clearinghouse for smaller companies.

• What we do. – Use our contacts, market knowledge & experience to get the best

terms and increase the likelihood for success.

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1

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7

1999 2006

Market Conditions - Multiples

2.5x – 7.0x

1.0x – 2.5x

Multiple of Annual Revenue

2x – 4x

0.5x-1.2x

x DN

Market Conditions – Future Multiples

Hosting Transaction Multiples1999 2006

• Lower industry Lower industry growth rates growth rates • High churnHigh churn• Pricing Pricing pressurepressure• Noisy Noisy advertising advertising environmentenvironment• No big new No big new buyersbuyers• Google, Yahoo, Google, Yahoo, etc.etc.• No barriers to No barriers to entry entry

10x

1x

Market Conditions – Deal Volume• Sharp increase in numbers of buyers.

– Buyers looking to offset difficulties in organic growth (churn, advertising noise, etc.)

– More companies have matured and have the systems and management to do an acquisition.

– Most are small to medium sized hosters buying out of cash flow.

• Sharp increase in numbers of sellers.– Customer base growth slows/stops/declines– Burnout– Static multiples

Market Conditions – Buyer Types• Consolidators

– Makes up the bulk of all buyers.– Looking to add customers to their existing infrastructure.– Concerned with profitability of acquired customers on their

infrastructure.

• Platform/Strategic buyers– Looking for a base of operations for a new product line or

company.– Concerned with systems, processes, network, employees &

profitability.

Price vs. Profits & Risk• Price paid (and when) is a direct function of;

– How profitable the business is to the buyer; and– How much risk there is of realizing that profit.

• Two examples– 100% paid upfront in cash means more risk for the

buyer and thus a lower price.– 100% paid over time based on profits means more

risk for the seller and thus a higher price.

Asset vs. Stock Deals• Asset deals

– Buyer purchases specific assets from seller. Seller retains everything else including employees, debt, etc.

– Typically includes customers, url and, if it’s a dedicated or VPS deal, servers

– Preferred by consolidators.

• Stock or equity deals– Buyer acquires all of the equity interests in the seller and takes over

the entire company.– More common with platform/strategic buyers who want all of the

operations and people.– Often more complex and risky than an asset deal.

How do buyers pay?• Equity interests of the acquiror

– Shares, LLC interests, etc.

• Assumption of liabilities– Debt, leases (equipment, office and data center), etc.

• Cash– Performance based earnouts, escrow, holdbacks, seller

financing, etc.

When do buyers pay?• Many possible options;

– Signing of the APA– Migration of customers– Holdback expiration– Specific dates following closing

• Holdback issues– Migration– Breaches of “Reps and Warranties” & fraud– Customer attrition (churn & inactive) – Seller obligations for transition / migration– Chargebacks & expenses

Valuation I• Multiples based on purchase price divided by historic

revenues or revenues based on the seller’s current customer base.

• Calculating revenues based on the seller’s current recurring revenue base.+ 10,000 customers @ $10/mo x 12 = $1,200,000+ 15,000 customers @ $15/mo x 12 = $2,700,000+ 25,000 customers @ $25/qtr x 4 = $2,500,000= Total Annualized Revenues = $6,400,000.

• Non-recurring revenues often don’t count.

Valuation II• Consolidating buyers concerned with their profitability, not

the seller’s.• Buyers look at a variety of things to determine profitability of

seller’s revenues to them.– Bandwidth usage– ARPU– Customer growth and churn rates– Support & infrastructure intensity

• Assets used to produce revenues are not separately valued – they are part of the revenue valuation.

Valuation III – Other Factors

• Control panel• Billing cycles &

Deferred Revenue• Credit cards &

information• OS• Equipment• Data center lease

• Employees• Type of hosting• Products• ARPU• DNS• Records

Valuation IV - Financials• Required level of financial detail increases with

transaction size.• Base requirement includes ability to track revenues,

customers & servers.• Inadequate financial reporting eliminates buyers and

hurts valuations.

Summary• Good news

– Transaction values stable.– More companies buying & selling.– Transactions fairly easy to accomplish for mainstream sellers at

market multiples.

• Not so good news– Transaction values at risk if big players reduce industry profitability.– Unique companies still more difficult to sell.– Few large buyers.

Endurance International - Overview• Founded in 1997• Backed by a $1 Billion private equity firm• A leading provider of Web Hosting services to small and medium sized

businesses • Serving over 230,000 customers world wide• Completed over 27 acquisitions in the last four years• 24 hour customer support via e-mail, phone and chat

• Highly automated, Operational Support System (OSS)• State of the art clustered Unix and Windows platform• Can easily private - brand for its multiple properties and resellers• Multiple brand strategy to reach certain market segments• Proprietary, 350-step Migration Methodology

Example Brands

Endurance’s Acquisition Criteria

• Shared Hosting Companies/Assets with 5,000 – 400,000+ Subscribers;

• Growing customer base;

• Data consistency;

• Sites hosted on Unix and Windows platforms;

• Small business Subscribers;

• Hosting packages priced from $6 to $50 per month;

• Credit card billing preferred;

• Technical resources available to aid in migration;

• Subscriber-base/asset sale preferred.