This article appears in the June 2005 issue of Web Host Industry Review magazine. Click here to subscribe.
June 3, 2005 -- (WEB HOST INDUSTRY REVIEW) -- In March, a consortium of seven private equity investment firms announced a definitive agreement to acquire SunGard (sungard.com) in a transaction valued at approximately $11.3 billion. This acquisition could mark the start of a new round of capital investment in the hosting industry by a new breed of investors who are willing to take a more aggressive, hands-on approach toward coaxing renewed revenue growth and profits from of underperforming hosting companies.
The consortium that put the SunGard deal together was organized by Silver Lake Partners and includes Bain Capital, The Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. L.P., Providence Equity Partners and Texas Pacific Group. The companies expect to complete the transaction in the third quarter of 2005. As a result of the deal, SunGard's board of directors decided not to proceed with its previously announced plans to spin off the company's availability services business.
While some might draw a strong distinction between SunGard's disaster recovery and business continuity services and a typical hosting service, the two businessess share the same fundamental value propositions and operating principles. The common value proposition is that it makes sense for enterprises to use off-site facilities to augment their in-house systems and software. The common operating principle is that both segments rely on centralized facilities that are shared by multiple clients contracting for services on a multi-year basis.
Investors have been attracted to this annuity service business model since it became prominent during the dot-com era. But, instead of early stage venture capital taking the lead in today's market, leveraged buyouts have become the new mode of investment. For those seeking to generate double-digit returns again after a long drought in the IT and telecommunications industries, levaraged buy outs create the new mode of investments.
During the Internet boom, traditional venture capital investors made their money searching for early-stage companies that could generate healthy multiples after a period of two to three years, either through acquisitions or IPOs. With IPO opportunities still relatively limited and acquisitions only paying modest multiples, investors are looking for another method to generate the financial returns that their backers have grown to expect.
The leveraged buyout specialists have demonstrated an ability to quickly multiply their investments by rapidly restructuring existing companies. These companies, like Sungard, typically have established businesses and brands, but have fallen on hard-times and need an injection of new leadership, renewed focus and refined operations to turn themselves around.
The buyout artist will place its own management team into key positions, thoroughly reevaluate the company's products and personnel, and aggressively cut back operating costs while it drives for renewed revenue growth with the goal of "flipping" the company within one or two years, for many times its original investment.
While these tactics have generated significant returns for leveraged buyout firms in consumer goods, manufacturing and other industries, they have failed in some technology cases. For instance, in 2001 Bain Capital made a $100 million investment in USi, a pioneer in the application service provider market, but has not improved the company's fortunes dramatically.
Despite some disappointments, the leveraged buyout business is a lot like the venture capital sector in its herd mentality. So you can expect to read about more leveraged buyout firms making strategic acquisitions in the IT and telecommunications industries, including the hosting marketplace. You might even get a call from one of these firms prowling for potential new investment prospects.
If you're a hosting company executive who has been struggling to survive and succeed in this unforgiving industry, an offer from a leveraged buyout firm or consortium may be the escape path you've been waiting for. But if you're an executive who is excited about the potential for more funding and support from these new investors, be aware that you may be viewed as part of the problem rather than part of the solution. They could make their investment and take your company in the process.
For those left to compete with the hosting companies the leveraged buyout firms acquire, get ready for a new round of more competitive players with more streamlined operations and more aggressive sales and marketing strategies and tactics.
