Want to Turn a 5x Valuation into a 7.5x? - Merge with a Registrar

On September 11, 2006 MelbourneIT (ASX-MLB) closed on its acquisition of web hoster WebCentral Group (ASX-WCG). The merger was announced on May 22, 2006. From announcement to closing shares of MLB rose from about $AUD 1.75 to about $AUD 2.10 at the time of the September closing.

Today MLB trades even high at about $AUD 2.90. With shares outstanding of about 76 million, MLB hits a market capitalization of $AUD 220 million. The market liked the deal.

Although year end 2006 numbers are not yet available (and some adjustments need to be made for the September acquisition) we estimate the business now trades at about 10x EBITDA and about 1.5x Price-to-Revenue.

But a look at the filings shows MLB acquired WebCentral for about 5x EBITDA. At the time of the acquisition MLB was trading at about 12x its EBITDA.

MLB was primarily a domain registrar doing about $72.2 million in revenue and $6.9 million in EBITDA. WCG was primarily a web hoster doing about $59.3 million in revenue and $12.7 million in EBITDA.

WCG shareholders were offered two choices. They overwhelming (90% of electors) selected the Option under which the could receive the most MLB shares in lieu of cash. That option granted them 1/2 cash and 1/2 MLB stock for each share of WCG. Each share was valued at $1.53. So they had to take half thier consideration for a 5x multiple but now have the other half trading at 10x for an average of 7.5x cash flow.

The new MelbourneIT is the Australian hosting powerhouse although Hostworks (ASX-HWG) and Bluefreeway (the reincarnation of Destra hosting) might put up a fight in managed and mass market hosting respectively.

The 5x EBITDA value for the hoster and the 12x EBITDA value for the registrar was "approved" by the stock market's trading, the investment bankers opinion, and ultimately by the shareholders. And the market continues to like the story. As I said the stock is now up to $2.90 per share. Bankers looked at previous transactions including; Register.com going private (9.4x EBITDA), Pipex acquiring Host Europe (8.9x EBITDA) as well as the trading of public comparables and signed off (for a fee).

But I wonder how many more of these combination we will see get done at these respective pro-rata valuations? Some argue a hoster's cash flow is more steady than a registrars (and has more growth opportunity). As both types of companies begin offering each others products, either through acquisition or internal development, we argue for valuation of both kinds of businesses to head toward a mean.