Hosting Con 2009 Interactive Workshop (Final Web)

Interactive Workshop: Valuing and Structuring Web Hosting Company Acquisitions Hillary Stiff, Managing Director C HEVAL C APITAL , I NC . [email_address] www.chevalcap.com

Disclaimer
This presentation is for discussion purposes and is not financial advice or a comprehensive discussion of the issues involved.
THE PURCHASE OF ASSETS OR BUSINESSES IS RISKY. SMALL BUSINESSES ARE OFTEN DEVELOPMENT STAGE OPPORTUNITIES WITH SIGNIFICANT FINANCIAL, TECHNOLOGICAL AND OPERATING HURDLES TO OVERCOME. PURCHASERS HAVE A MEANINGFUL RISK OF LOSS OF THEIR ENTIRE PURCHASE PRICE.
Please be sure to consult your financial advisors when valuing a company, considering the sale or purchase of a business or making other financial decisions.

Today’s Goal & Agenda
What determines the value and structure of a hosting company purchase/sale
Valuation Categories & Drivers
Buyer Types
“ Let’s Make A Deal” Game
Extras!
Valuations - Historic, Current & Future
Valuation Issues
And more!

Background – Cheval Capital
Who we are
Investment bankers active in hosting/ISPs since 1996
Completed over 145 Hosting/ISP acquisitions including transactions such as the Endurance/iPower merger
Who we have worked for
Endurance Int’l Group, Rackspace, Hostopia, Midphase, Jumpline, Verio, etc.
What we do
Represent buyers & sellers of hosting, telecom and related companies
Distribute a weekly listing of sellers, creating a deal marketplace for small and mid sized companies

What are examples of drivers that affect the valuation of a hosting business?
Major Categories:
Financial
Technical/Engineering
Customers
Product/Service offerings
Legal
Qualitative
Buyer

Financial Drivers
Total Revenue & Cash Flow (incl. growth)
ARPU – Average Revenue Per User
Profitability – NI, NPBT, EBIT, EBITDA, Gross Margin
Cash collected vs. revenue recognition
Recurring vs. non-recurring revenue
Customer credit card information
Billing system
Deferred revenue
Stability of Rev/CF
Balance Sheet & debt
Equity/ownership structure
Equipment owned vs. leased
Billing method
Billing cycle distribution
Refund/chargeback history
Audits
Owner related expenses ex. cars, cell phones, T&A
Ongoing obligations (e.g. datacenter)
Pre-paid expenses
Cost of goods sold
Taxes/NOL’s – Net Operating Loss
Forecast and projections
Recurring vs. non-recurring expenses

Technical/Engineering Drivers
Control panel (proprietary vs. off-the-shelf)
Platform – Unix vs. Windows
Ability to migrate customers
Infrastructure owned vs. leased
Age of infrastructure
Resource usage (Bandwidth, Storage, etc)
IP addresses (ARIN vs. borrowed; excess)
Efficiency of infrastructure
Capital expenditure needs
Software developed
Control panel fit with buyer

Customer Drivers
Growth rate
Loss/churn rate
Cost to acquire a customer
Brands
Pricing strategy
Age of customer base
Resellers/affiliates and their cost
Advertising methods
Customer support metrics/volumes
Customer satisfaction
Domain name renewal rate
Commissions/sales incentives
Sales/Marketing employees
Cust. Support hours
Type of support offered (phone, email, etc.)
In-house vs. outsourced support.

Product/Service Drivers
Type of hosting offerings
Package configuration
Overselling
Customer product/service usage
Breadth of offerings
Internal vs. 3 rd party offerings
New product development cycles
Up-selling strategy

Legal Drivers
How is purchase structured - Asset vs. Stock
Customer contracts
Potential liabilities/pending litigation
Legal/corporate structure
Royalty/licensing agreements
Environmental matters
Trademarks/Intellectual Property
Employee benefits programs
Severance agreements
Customer disputes

Qualitative Drivers
How well do the two companies fit
“ Personality”
Type of Business
People
Cleanliness of data, records and reports
Willingness to share
Degree of certainty & trust
Culture
Reputation
Market Position

Buyer Drivers
Consolidators buy revenue/customers to add to consolidator’s existing infrastructure
They care about the cash the seller’s customers will generate on their platform
Strategic/Platform buyers seek to fulfill strategic goals when acquisition is quicker or cheaper than building from scratch
They care about the current business as a platform for the buyer’s future operations
Buyers pay more for companies that fit

What are common themes among almost all of these drivers?
Most drivers relate to cash; either (a) the amount the business will produce (for the buyer) or (b) the risk of getting it
The relative importance of any of these drivers depends on each individual company and buyer

“Let’s Make A Deal”
Win amazing gifts and prizes!
Impress your friends and colleagues!
Did we mention the great prizes?

Teams
Consolidators tend to care about the cash the seller’s customers will generate on their platform
Strategic/Platform buyers tend to care about;
The current business as a platform for the buyer’s future operations.
A technology or product that can be cross-sold to existing customers.

Case # 1
A hosting company has been adding new customers rapidly but has a high churn rate due to poor customer service and a recent outage.
Q - How do you (consolidator or strategic) view this and why?
A - The rapid growth, assuming it is cost effective, would be appealing to both. The Consolidator may look at the poor customer service and outages as something that is easy to fix on migration. The Strategic may believe it is an inappropriate platform to build a business on.

Case # 2
A hosting company has a practice of selling pay-in-advance plans. They recently ran a popular promotion that encouraged customers to renew for an additional three years.
Q - Why is this significant?
A - The seller has taken a chunk of the revenues for the next three years out of the business. The buyer will have to support these customers with no cash coming in the door.

Case # 3
A hoster that bills the majority of its customers monthly by credit card does not have access to the customer credit card information.
Q - For which type of buyer (strategic or consolidator) is this generally likely to be a bigger issue post-closing?
A - Consolidator. The Consolidator needs the credit card information in order to migrate the customers onto its billing systems. The Strategic can continue using the existing billing platform and obtain the credit card information slowly over time.

Case # 4
A dedicated hoster has leased servers in a number of data centers in different geographic areas. (All leases are month-to-month.)
Q - How would this affect your (strategic/consolidator) likely valuation?
A - Strategic – If the equipment is spread out too much, there is no platform/base on which to build. Consolidator – May make the physical migration more costly and cumbersome.

Case # 5
A hoster is adding customers quickly through affiliate sales at a price equal to one year’s revenue.
Q - What do you need to know in order to determine the value of these customers?
A - A buyer would need to understand how long the customers could be expected to stay on the system. Also helpful would be knowing if the buyer would be able to continue to add customers through this relationship.

Case # 6
Consider two hosters: (A) has a business that largely consists of a single hosting product (e.g. VPS); and (B) has a multi-product business (e.g. shared, VPS and dedicated)
Q - Which hoster may have a larger pool of prospective buyers?
A - The single product line business would typically have a larger pool of potential buyers. They would both have the single and multi-product companies as prospective buyers while the multi-product companies have only the other multi-product companies as prospective buyers.

Case # 7
A co-location company’s owners run a lot of their personal expenses through the company including car leases for them and their two children, gas, cell phones, and a couple of trips each year.
Q - What would some issues be in valuing and acquiring this company.
A - Determining the cash flow of the business without these expenses. Are there any tax mis-statement issues that could affect the new owner.

Case # 8
A hoster has a proprietary control panel.
Q - How might this affect your (strategic/consolidator) valuation? Does your answer change if it is well documented and full featured ?
A - Consolidator – No affect as long as (1) the customers could be migrated off the control panel without difficulty; and (2) the buyer’s control panel has the same or better features. Strategic – Possibly negative if the control panel was unsuitable for future growth. If it was well document and full featured it may add some value for the Strategic.

Case # 9
A hosting company has 18 months remaining on its data center lease and 12 months remaining on its office/support center lease.
Q - For which type of buyer might these leases more affect the price they are able to offer?
A - Neither. The Consolidator doesn’t care as they would be purchasing the customers and these leases would be the responsibility of the sellers. The Strategic would generally be looking to continue operations as-is for some period of time.

Case # 10
A hoster has significant revenues from domain registration and renewals
Q - How do you value these revenues?
A - The valuation would depend on the (1) the cash flow margin for those revenues; (2) the renewal rate; and (3) how many are associated with a hosting account.

Case # 11
A shared web hosting company has what is considered in the industry as a “high ARPU”.
Q - Why could this be a negative?
A - The customers may be paying an above market price and likely to move to other, lower priced options. This may be exacerbated if they are “jostled” during an acquisition. Note: There was some disagreement over this answer. Some felt it was more of a positive than most perceived.

Case # 12
A company has a significant amount of website design and development business.
Q - Do you value this revenue?
A - If the Consolidator provides web design then this business may have some value. This should have some value for the Strategic if they are keeping this line of business and it has been run profitably.

Case # 13
A hosting company has outstanding liabilities to several parties.
Q - For what type of buyer might this affect the price they are able to offer more?
A - Probably the Strategic buyer’s offer price. If the Strategic purchases the company and steps into the obligations of the seller, then these liabilities would reduce the price they could offer. If the Consolidator purchases only the customers they would leave the liabilities with the seller and the liabilities would not affect their offer price.

Case # 14
A web hosting company has an infrastructure that has many older devices.
Q - For what type of buyer (consolidator or strategic) might this affect the price they are able to offer more and why?
A - Probably the Strategic buyer as they would be relying on the existing infrastructure going forward. If it required an unusual amount of capital expenditures, then those would lower the price they could offer or cause them not to bid. If the Consolidator was moving the customers onto its own infrastructure this may not have any affect.

Case # 15
A hosting company has a base of largely long standing, customers who are very satisfied with their service and paying market prices. However, the company has not created new offers or products for these customers in some time.
Q - How would this generally affect your valuation and why?
A - Positively for both – There may be an opportunity to sell new products and services to these customers.

And the winner is …
Thanks to everyone for participating and a special thanks to Elliott Noss of Tucows/OpenSRS.
Be sure to pick up a copy of the slides from us ( www.chevalcap.com ) or HostingCon. There are 15 extra slides on valuation and valuation issues.

Extra Slides!
Comparable Valuations
Public Company Valuations
Private Company Valuations in Hosting - Past, Present and Future)
Summary of some key valuation issues
Price Versus Terms
Evaluating an offer
Leases
Deferred Revenue
High Growth

Comparable Valuations
One common way to determine an appropriate valuation for you company is to look at the “comps” or comparables
Comparables could be the relative values of the public hosters or the sale prices of companies similar to yours
Be careful about finding true comparables for your business
Comparables are not the total story, each seller and buyer are unique as are transaction terms, both affect prices
Look carefully at EBITDA, it can vary greatly between two very similar hosters due to such things as affiliate marketing costs, operating leases for equipment, accounting method (cash vs. accrual), personal expenses, etc.
The M&A market for hosters is competitive - if a buyer offers too little, sellers have other options and vice versa

Public Companies – July 21, 2009
Annualized Enterprise Region/Company Revs ($ mil) Value/Re
North America
Savvis $ 886 1.4x
Rackspace $ 580 3.1x
Navisite $ 149 1.2x
Web.Com Group $ 111 1.4x
Peer1 $ 91 1.5x
Group iWeb $ 25 1.7x
Europe
United Internet $ 2,403 1.7x
Dada $ 218 1.0x
Net Benefit Gp $ 64 1.7x
IOMart Gp $ 19 3.0x
Australia
Melbourne IT $ 151 1.3x

Private Valuations ‘96 to ‘07
Another comparable are the prices hosting companies are being bought and sold for
Industry prices peaked at the end of the 1990’s and drifted downward until 2007
Prices in the U.S. were very well defined during the 2005-2007 period due to a large number of transactions. Almost all were between 1.0x to 2.0x annualized revenues
Hostway/Affinity; Terremark/Data Return; Navisite/Alabanza; Endurance/iPower; Endurance/PowWeb; WebSitePros/Web.Com; Endurance/FatCow
European transactions seemed to get a significant premium
1&1/Fasthosts; HostEurope/Pipex

Valuations ‘07 to Mid-2008
Some larger, apparently strategic transactions at higher multiples in both hosting & adjacent industry segments
Intuit/Homestead; Abry/HostedSolutions
Transactions occurred with new entrants & capital coming into hosting
Deluxe/Hostopia; Wachovia/HostMySite; Spire/Carpathia
European transactions at a premium
Very active & vibrant market
A number of larger deals were completed with great price variation in some transactions
Deluxe/Hostopia; Wachovia/HostMySite; Intuit/Homestead; Abry/HostedSolutions; Dada/Namesco; Layered Tech/Fastservers
The tight pricing band seemed to have been broken with more variation in prices; high and low
General trend seemed to have been on the uptick
Strategic buyers in the market for the first time in a long while

Valuations Mid ‘08 to Current
Fewer completed transactions
Fewer buyers
Increased caution due to economic concerns
Less debt/financing available
Fewer sellers
Sellers have fewer alternative business opportunities
Sellers believe current market values are lower than what they could get in the future
Few distressed properties
Prices are back to 2005-2007 levels
Hosting revenues seem to be stable or slightly declining
Our deep pocketed buyer is still buying at a premium

Future Valuations
The outlook is cloudier than any time in recent memory
Positives
We have large buyers still buying at premium prices
Industry revenues & cash flow have generally held up
Concerns
When current buyers use up their acquisition cash they may not be able to replace it and may have to stop buying
Underlying economics of the business may deteriorate with the economy and continued competition of single purpose hosters (blog platforms, photo sites, social networks, etc.), etc.
Organic growth is difficult

Some Valuation Issues
Price Versus Terms
Evaluating a Purchase Offer
Leases
Deferred Revenue
High Growth

Price vs. Terms - 1
Non-price terms of a deal can have a major impact on the price paid
Generally;
(1) The more risk a party bears the more compensation they should get for taking those risks; and
(2) Money today is worth more than money tomorrow.
Some rules of thumb;
Payment timing (1 & 2 above). Buyers that pay more of the purchase price at closing would likely pay a relatively lower price than those that pay more over time
Payment and transaction certainty (1 above). Buyers that offer more assurance that they will make payments would likely pay a relatively lower price than others
Churn protection (1). Buyers typically pay more if a portion of the purchase price was tied to customer retention (as it reduces their risk)
Other legal issues. There are a variety of legal issues in most deals that can affect the risk to either party, and as a result, the price

Price vs. Terms - 2
A highly subjective chart on 2008 data
12 hosting transactions.
Chart based on risk of terms to buyer (5=high)
Seller risk chart would generally be a mirror image.
Note fluctuation at constant risk levels and at decreasing risk.

Evaluating An Offer - 1
One way to evaluate a purchase proposal is to compare it to the amount of cash you are getting from your business
The cash you get from your business consists of;
Salary, bonuses and other distributions of cash to its owners
Cash value of benefits, incl. health care, car leases, etc.
Cash building up in the business that won’t be used
Less what your business may be costing you
Salary, bonus, benefits you would earn if you didn’t work in the business
Cash you are/have put in to the business
Other cash “Opportunity Costs” of the business (for example, rent from a building you may own that the business is using.)

Evaluating An Offer - 2
A - The seller would need 13.7 years of cash flow to equal a price of 1.3x revenue
B - The seller would need 5.2 years of cash flow to equal a price of 1.3x revenue.
* Does not include taxes on income or sale.
* Example only, does not reflect any company.
1.3x 1.3x Price/Revs $13.00 $13.00 Purch Price $2.50 $0.95 Owner CF 5.2x 13.7 Price/OCF 5.0% 0.5% Capex % 15.0% 45.0% Sales % 30.0% 25.0% G&A % 25.0% 20.0% COGS % $10.00 $10.00 Revenues Hoster B Hoster A

Leases
The typical view is that the physical plant of a company generates its revenues and cash flow and thus deemed included in the purchase price
Equipment that is leased, rented or that must be otherwise replaced by the buyer, generally reduces the price the buyer can pay
The purchase price the buyer can pay is reduced by;
The amount of debt and leases assumed by the buyer
The cost of equipment the buyer must replace
When the buyer only takes customers, the seller would have to repay outstanding debt/leases out of the price.

Deferred Revenues - I
Deferred Revenue - Collecting payment today for services to be delivered in the future creates a liability
Buyer’s adjustment for Deferred Revenue can vary from;
No adjustment
An adjustment based on the cost of providing the service
A $ for $ reduction for the amount of the liability
Double whammy for prepaids >1 year. Often an adjustment for the cost of providing service and the buyer typically is willing to pay little for these customers
Issue is risk and, for some buyers, accounting. Cash flow should not necessarily be the issue (see following cash flow slide)

Deferred Revenues - II Cash Flow Comparison – Annual vs. Monthly Customers $180 $180 $180 $180 $180 $180 CF with Monthly Pay 12 12 12 12 12 12 Number of Subs Renewing All Monthly Cust $180 $180 $180 $180 $180 $180 CF with Annual Pay 1 1 1 1 1 1 Number of Subs Renewing Jun May Apr Mar Feb Jan All Annual Cust 12 Total Customers $15 Cash/Sub/Month

High Growth
Very high growth companies are a unique valuation challenge
Growth engine can be quite valuable if new customers are of good quality and their cost to add is reasonable
The valuation challenge comes from;
It can be difficult to tell if customers are of good quality until they have a renewal history
It can be difficult for buyers to be confident that growth will continue
There is likely to be a smaller pool of potential buyers during the high growth stage

Disclaimer
This presentation is for discussion purposes and not financial advice or a comprehensive discussion of the issues.
THE PURCHASE OF ASSETS OR BUSINESSES IS RISKY. SMALL BUSINESSES ARE OFTEN DEVELOPMENT STAGE OPPORTUNITIES WITH SIGNIFICANT FINANCIAL, TECHNOLOGICAL AND OPERATING HURDLES TO OVERCOME. PURCHASERS HAVE A MEANINGFUL RISK OF LOSS OF THEIR ENTIRE PURCHASE PRICE.
Please be sure to consult your financial advisors when valuing a company, considering the sale or purchase of a business or making other financial decisions.

Please Complete Survey! Hillary Stiff, C HEVAL C APITAL , I NC . www.chevalcap.com Session Track: Business Development Session Title: Interactive Workshop: Valuing and Structuring Web Hosting Acquisitions

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Hosting Con 2009 Interactive Workshop (Final Web)

by Cheval Capital, Inc on Aug 11, 2009

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Hosting Con 2009 Interactive Workshop (Final Web) — Presentation Transcript