Hosting M&As sustain slow, continual growth in value added service market

By Rawlson O'Neil King, theWHIR.com

January 31, 2001 -- (WEB HOST INDUSTRY REVIEW) -- The global demand for Web hosting services triggered a wave of mergers and acquisitions in the past. Expect the consolidation trend to continue albeit at a slower rate according to Daniels and Associates (danielsonline.com), a leading financial services consultancy.

Though interest will not wane concerning the merger and acquisition of successful hosting providers, the emphasis will shift from companies with primarily a shared hosting base to companies whose core service offerings include higher-end services.

According to Bob Allison, a senior vice-president at Daniels who is intimately involved in the specific arrangements of financing, acquisitions and divestitures for larger hosting firms, industry participants can expect this shift to fundamentally impact the merger and acquisition environment.

"The evolving nature of the financing market and the changing needs of the acquiring companies are the primary factors that slowed things down last year and will continue to slow things down in the first part of this year," he said in an exclusive interview with the Web Host Industry Review.

Allison thus does not attribute the slowing of the M&A environment to a faltering and inhospitable U.S. economy, but to a market that has become much more sophisticated concerning its purchases and sales of hosting assets.

While the first wave of consolidation involved the development of a set of basic hosting services and infrastructure in the form of shared hosting assets, the current round of consolidation will be characterized by the rollout of value-added services that can be layered on top of basic networking architecture.

Indeed, Daniels and Associates recognizes this trend because the company itself is a prominent investment bank for the Internet and telecom sectors and is itself the most foremost advisor on merger and acquisition strategies within the Web hosting industry. The company's own involvements have indicated that the M&A market is shifting towards more advanced services.

Over the past four years, Daniels and Associates has advised on more than $1 billion in transactions within the Internet service and presence provider marketplaces. Most notably, the company lorded over the fast and furious wave of consolidation that engulfed the entire industry by 1996. This wave was mostly characterized by the creation of huge shared hosting titans.

The company represented Verio Inc. (verio.com) in those early days of commercial Internet services and transformed it into the world's largest shared hosting provider through the acquisitions of data center giant TabNet and WebCommunications, LLC (webcom.com), the world's first hosting company. Daniels and Associates also facilitated the acquisition of HostPro (hostpro.com) by Micron Electronics Inc. (micron.com) and the Interliant (www.interliant.com) acquisition of Digiweb's (digiweb.com) shared hosting assets.

But as the market matured, Daniels conducted mammoth deals designed to enlarge the added service capacity of large telecommunications companies and premier Internet commerce shops.

Indeed in the summer of 2000, the company represented InQuent Technologies (inquent.com) and helped it obtain a strategic $100 million investment from SBC Communications Inc. (sbc.com), the huge southern-based Baby Bell. And most recently, Daniels represents IMC Online (imconline.com), one of the largest Windows NT-based Web hosting service providers, in its sale to VIA NET.WORKS (vianetworks.com), a leading single-source provider of Internet access and services to businesses in Europe and the Americas.

These recent transactions indicate that a huge shift has occurred in the Web hosting market, one that Allison believes hosting companies should take note of as the industry evolves and matures.

"Most people in the industry are trying to migrate toward higher margin value added services rather than basic communication services which can be turned into a commodity," says Allison.

This means that the smarter hosting services are gearing their wares toward managed and professional services in an attempt to attract the more sophisticated buyers of hosting assets such as telecommunication operators and large scale bandwidth providers.

Indeed, industry valuation trends of private company transactions indicate that dedicated server and application hosting operations usually fetch 26.3 times their revenue at sale in comparison to shared hosting operations that only fetch 4 times their revenue streams.

This fact has caused many hosting firms to devise exit strategies that involve high-end hosting, but Allison also reminds firms to ensure they generate and sustain positive operating cash flow in order to generate and sustain the interest of potential acquirers or financial backers.

Despite slower momentum, Allison expects the hosting industry's M&A environment will still undertake impressive and optimistic growth.

About the Author
Rawlson O'Neil King is a managing editor and analyst at the Web Host Industry Review. Before joining theWHIR, Mr. King was Director of Corporate Communications at WebHosting.Com. During his tenure at Canada's most successful Web host, he established ineedsupport.com, the first branded destination customer care site in the shared hosting industry. He has prior experience as an IT consultant who served non-profit organizations, government and private industry. He holds a Bachelor of Journalism degree from Carleton University. Mr. King's column appears in theWHIR weekly.