Mergers and acqusitions in the web hosting industry accelerated in the first half of 2006, as investment capital flowed into the sector, which just a few years ago was scorned by Wall Street. While most of the deals have featured private investors, the public may get the chance to get in on the action in coming months, as Go Daddy and Hostopia are planning initial public offerings.
The improved environment for hosting M&A was the focus of several panel discussions at last week's HostingCon 2006. "The acquisition market is heating up," said Hillary Stiff of Cheval Capital, an Alexandria, Va. investment banking firm that specializes in the hosting sector. "We're getting more buyers into the market. It's harder to get organic growth, so people are looking to buy companies. There are also a lot more companies looking to sell."
"We're seeing increased M&A activity," agreed Paul Stapleton of DH Capital LLC, a New York investment firm active in the ISP and hosting markets. "More people will be buying hosters. Debt is returning to the market, more private equity is returning to the market, and there are more and more exit strategies for capital in this sector. The capital markets are open for hosters."
The most visible deals came in a flurry of activity in early May. On May 2, start-up Demand Media Inc. bought domain registrar eNom, which also has a large hosting operation. On May 5 investment firm GI Partners said it purchased The Planet and EV1Servers, the two largest dedicated hosting specialists. Then on May 10 Germany's United Internet bought UK provider Fasthosts for $115 million.
But there have been many smaller deals taking place under the radar. Cheval Capital has arranged 18 hosting asset purchases in 2006, while DH Capital says it has closed 20 deals over the past 18 months. Most of the sales have taken place in shared hosting, Stiff said. "Consolidators make up 95 percent of the buyers," she said. "They're going to just buy the customer and URLs and layer them into their infrastructure."
Endurance International has been the most active consolidator, buying 27 shared hosting companies in four years. The Burlington, Mass. company is backed by a private equity firm with $1 billion in assets. Endurance started the BizLand brand, and has since bought FreeYellow, Virtual Avenue, HyperMart and FatCow, among others. "We tend to try and maintain the forward-facing brand," said Joe Bardenheier IV, vice president for development at Endurance. "We don't want to break anything. It's very important for us and the seller that we're managing the brand in as congruent a fashion as possible."
If the current market presents opportunities for buyers, is the same true for sellers? This was the big question for hosting company owners attending the M&A panels at HostingCon. Stiff, who typically represents buyers, said that the value of a shared hosting company has declined steadily in recent years, falling from a range of 2.5 to 7 times annual revenues in 1999 to a range of 0.5 to 1.2 times annual revenues today. "Multiples have continued to decline," said Stiff. "Currently, an attractive shared hosting company will sell for 1 times annual revenues. Multiples are probably going to stay where they are before tranding lower."
Most owners scoffed at the notion of selling their company for the equivalent of a year's revenue. Stiff acknowledged that those valuations won't convert skeptics into sellers, but said burnout is an issue for many hosting company owners, some of whom founded their companies before the dot-com boom. "Also, the multiples have been static long enough that sellers have decided not to wait for them to rebound," said Stiff.
If you're thinking about selling your company, strong record-keeping is essential, according to Robert Leptich, managing director of Ascend Partners, a Dallas investment banking firm focused on the hosting industry. Leptich said some hosting companies have not kept thorough financial records, making it more difficult for buyers to value the company. "A lot of companies we talk to just don't have the information they need," said Leptich, who said profit and loss staements, balance sheets and cash flow statement are the minimum.
"There are a lot of mid-sized hosting companies that are attractive, but can't provide detailed financial statements and are essentially unsellable," said Stiff. "If you don't have your financial house in order, you'll lower the number of potential buyers and you'll also lower the price."
On the IPO front, domain registrar Go Daddy and reseller speicalist Hostopia have both announced their intent to go public and filed S-1 registration documents with the Securities and Exchange Commission. Neither company has set a date for their IPO.