(WEB HOST INDUSTRY REVIEW) — In a deal that has been the topic of much speculation around the hosting industry for at least several weeks, investment firm GI Partners (www.gipartners.com) and hosting company SoftLayer (www.softlayer.com) revealed on Tuesday that GI had acquired a major equity interest in SoftLayer.
Though the official announcement did not reveal the details of the transaction, the companies did say that SoftLayer’s management team, along with GI, had acquired all the equity in SoftLayer, between them.
The implication – based on the nature of GI’s other dealings in the hosting business – seems to be that the investor acquired a controlling interest in the hosting provider.
“GI did this to get a controlling interest,” says Phil Shih, analyst at Tier 1 Research (www.tier1.com).
SoftLayer adds an interesting asset to a growing ecosystem of hosting properties managed by GI. The company owns dedicated hosting provider The Planet, along with colocation provider Telx (though that company is expected to go public sometime this year), an interest in Digital Realty Trust, as well as a recently-acquired interest in data center company ViaWest.
Softlayer announced two weeks ago that it earned $60 million from January 1 through June 30 of this year, and is on track to earn $125 million in 2010. According to the same announcement, the company is now hosting 30,000 servers.
The most obvious area of synergy among those properties is between SoftLayer and The Planet. The two are direct competitors with a well known history. Much of the founding management team at SoftLayer worked at The Planet prior to its acquisition by GI. And, while the companies haven’t commented on it officially, the SoftLayer deal would presumably resolve the years-old litigation against that company by The Planet.
There has been speculation about the possibility of merging The Planet and SoftLayer, though no official word on that has been released. It is reasonable to assume that more information on how the properties might fit together will be forthcoming.
Shih says his feeling is that the valuation in the SoftLayer deal is a fair bet to be at the top end of valuations industry-wide.
“SoftLayer is an extremely unique asset,” he says. “They have a very strong point of differentiation with their portal, with their platform and with their automated provisioning. And when you bring it together, it has created a system that pretty much no hosting company out there has. Its ability to scale and expand provides the company with a lot of upside potential. I think that’s what generated the interest from GI, and it’s what pushed the valuation up.”
While major acquisitions in the hosting space often see the management of the acquired company depart shortly thereafter, George Karidis, chief strategy officer at SoftLayer, says there was no interest among the SoftLayer management team to cash out. Everyone involved still has a significant stake in the company, and an interest in building the business in the future.
“We are, as a management team, rolling a lot of our equity into the new organization,” says Karidis. “A few folks are taking some money off the table, but we’re all keeping as much in play as we took off. And [SoftLayer CEO Lance Crosby] is well beyond 50 percent, what he’s keeping in the company to grow the business. So, we’re all tied in, we’re all committed and we all want to be here. I don’t believe you’ll see anybody at a senior level at SoftLayer leave in the near term. And I don’t see when any of us would leave.”
According to Karidis, the acquisition, from SoftLayer’s end, was entirely about increasing the company’s access to (and lowering the cost of) capital. Prior to the GI acquisition, SoftLayer’s debt was entirely based on lease lines, and not at all on equity, he says.
“The 10 [founders of SoftLayer], funded the company with very little equity and, largely because they wanted to maintain equity control, used lease lines, which in the early days is expensive,” says Karidis. “The way we funded our capital was to borrow money from leasing companies. So when we bought our network gear or servers, we were financing those on an operating basis. So would match the revenue cash flow of a server to the lease payment related to the server. The other piece is that we were amortizing the capital over the life of the lease payments.
“It was very expensive money. This allows us, the borrowing that we’re doing, along with the equity infusion, to lower our cost of capital pretty dramatically. So when we’re buying servers, they immediately generate more cash flow, rather than having a one-year or two-year payback on that equipment.”
Through the presence of a big equity sponsor, and the consequent improvement in lending rates, he says, the acquisition improves just about every line on SoftLayer’s financials
“We’ve been moving quickly to lower that leasing cost over the last several months, or years. We’ve improved that, and I think [the GI deal] just gets us to the next phase with a good equity partner that absolutely gives us the right mix of equity and debt to take the business forward.”
Karidis says GI’s intention in acquiring SoftLayer was to take on the company’s management long-term.
“That’s key to everything we did with them,” he says. “They pretty quickly caught on to the differences we have in the market – largely the automation, the way we provision things and the way we ultimately manage the infrastructure. They got that pretty quickly, and they understand that’s where the value is, and in fact that’s what they’re investing in, is our ability to maintain that leadership position. So absolutely, we’re in charge, and we’re going to build this and grow it forward and look at them to support as we need help, whatever that happens to be.”
While we can only speculate at this point about the prospect of the merger of SoftLayer and The Planet – and the long-term potential for an IPO – that prospect remains one of the most intriguing elements of the deal.
“The potential to merge the merge the two companies to create a company with the kind of scale that will interest the public markets is probably the ultimate end-game,” says Shih.
About Liam Eagle
Liam Eagle has worked as a contributor to the Web Host Industry Review since its inception in 2000, and as editor since 2003. He has been editor of the WHIR's print magazine since its launch. His daily involvement in the gathering and reporting of Web hosting news and his regular interaction with Web hosting leaders gives him an uncommonly broad appreciation of the issues and tends facing the business. Through his WHIR blog, Liam spots Web hosting trends and offers opinions on the industry-wide impacts of major developments and the motivation behind big announcements. Follow him on Twitter @liameagle
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