August 21, 2002 - The current fiscal constraints afflicting the U.S. economy will continue to cripple notable players in the Web hosting industry. Without the ability to raise capital on open equity markets, many firms are dependent strictly upon their respective cash flows to finance their operations.
During the Internet boom, the economy was driven by low inflation and high business investment, mostly in computers and telecom equipment. Rampant growth and the deregulation of the telecommunication sector saw institutional and personal investors pour billions of dollars into telecom, hosting and application service providers on the assumption that the market would grow exponentially along with the stock price of many of their investments.
While the market for hosting would continue to grow, the appetite to feed the capital markets with investment dollars in order to maintain extravagant technology outlays would crumble. Over-investment in the sector without tangible returns, and continuing financial scandals bedevilling Wall Street would lead to the collapse of investor confidence. The result, according to Bob Allison, Senior Vice President at Daniels & Associates (danielsonline.com), "is that now it is extremely difficult to raise any equity capital and it is near to impossible to raise any debt capital within the hosting sector."
As a leading specialist in Web hosting mergers and acquisitions, Daniels & Associates has very keenly observed the trends within the marketplace. "In the venture capital community, there is a lot of money, but many investors have taken tremendous losses in this area," states Allison. "Unless a hosting investment is proven, nobody will fund it. Investors are only interested in good operators who are profitable, hold no debt and demonstrate that they are continuing to grow."
With this approach now permeating the investor mindset, a great deal of investment capital has dried up. As a result, many noteworthy but unprofitable telecommunication firms and service providers have been devastated by the declining value of their stock issues.
Telecommunication firm Qwest which traded at $24.20 a year ago, now is trading under two dollars. As a result of its declining market capitalization, the company recently posted a $1.14 billion loss, which including $926 million in charges, amounted to a loss of 68 cents a share. With the company's data services being hurt by slow demand in the second quarter, management decided last week that it would eliminate two-thirds of its data center operations in order to save money, which will no doubt negatively affect the company's clientele.
Earlier this month, Digex, Inc., an affiliate of the mega-bankrupt telecom WorldCom, announced that it would cut 20 per cent of its staff, or about 200 employees in a bid to become financially self-sustaining. The managed hosting firm, which traded at $6.35 a year ago, currently is trading under fifty cents, maintaining a market cap of only $11.5 million.
With many telecom and hosting firms in financial turmoil, IT consultants such as Doug Kaye (rds.com), author of the influential book, Strategies for Web Hosting and Managed Services, expects that many hosting providers will fail due to the lack of capital and debt financing available to the sector.
"The companies who don't have profits are in trouble," says Kaye. "Presently those companies are simply burning cash. Without the ability to raise more cash, they will not have the capacity to finance their operations."
As a independent hosting consultant who works with independent hosting agents such as Ramp^Rate and CanXCentral, Kaye notes that he advises his corporate clients to select complex hosting companies or data center operators who are profitable and immune from financial difficulties.
Allison has also observed the same trend with corporate Web host clientele. "Bigger corporate clients are doing a tremendous amount of due diligence before selecting a host," he states. "With the customer being sensitive to the financial stability of service providers, many are selecting hosting companies on the quality of their financial statements."
"The focus is on finding companies with positive cash flow and low or inconsequential debt."
