Data Centers and Cloud Providers Targeted Early and Often in 2011

While there were only a handful of ILEC deals to speak of in 2011, telcos of all shapes and sizes kept The Deal Advisor busy this year with ventures into data centers and cloud services. Over the past twelve months, many telcos joined a diverse group of companies ranging from Best Buy to VoIP providers to cablecos that made acquisitions in the data center and managed services space. In the deals we observed, communications providers shelled out nearly $8.2b at an average price tag of nearly 5x revenue to get a piece of these growing industries.

A trio of large publicly-traded ILECs made the biggest splashes into the data center arena in 2011, spending nearly $7.5b to acquire 3.5m square feet of data center space. Verizon got the action started with its $1.9b purchase of Terremark and its 13 data centers in January. Shortly after Verizon closed on its deal, CenturyLink picked up industry giant Savvis for $3.2b in what was the year’s largest data center deal. With the Savvis purchase under its belt, CenturyLink immediately became one of the largest data center operators in the U.S. with 48 facilities totalling 1.9m square feet. Not to be out done, Windstream announced on August 1st that it had purchased telecom services provider and data center operator PAETEC for $2.3b, picking up 7 data centers and an expansive fiber network in the deal.

While the big boys dominated the data center M&A scene, some relatively smaller, regional telcos moved into the cloud services space with a string of acquisitions in the latter half of the year. In July, New York-based Warwick Valley Telephone snatched up Philadelphia-based hosted VoIP and managed services provider Alteva for $17m. Then in November, Kansas-based telco Twin Valley Telephone acquired a majority stake in IT services and cloud computing company, ISG Technologies. Most recently, North Carolina-based ILEC North State Communications acquired a neighboring managed services provider and data center operator, DataChambers, to round out a busy year for the telcos.

While the size and scale of the data center and cloud purchases varied in 2011, the acquiring telcos shared similar motivations in making their deals. First,  the acquisitions furthered their efforts to diversify service and revenue mixes, shifting away from their reliance on traditional voice lines. Secondly, whether buying managed services providers, data centers, or both, the companies acquired portfolios of services targeted towards the higher ARPU-business customers. Lastly, through investing in data centers and cloud services, telcos are getting into businesses with attractive growth profiles.

Though projections of future growth in cloud spending and adoption range widely, all forecasts for the industry point upward. IDC estimates that spending on public cloud infrastructure will expand by a compound annual growth rate of 27.6% over the next four years, reaching $73b by 2015. Meanwhile, the Open Data Center Alliance (ODCA) expects cloud adoption amongst businesses of all sizes to triple over the next two years, with 40% of companies moving towards a cloud based computing infrastructure by the end of 2013.

The industry outlook for data centers is equally bullish, fueled at least in part by companies looking to outsource IT infrastructure to data centers. Data center industry analyst Clayton Moran expects colocation spending to increase 15%-20% in 2012, while a recent Gartner study projects that spending on data centers will hit $127b by 2015, up from $88b in 2010. 

By contrast to these rosy outlooks, telcos lost another 10% of voice access lines in 2011, and continue to face stiff competition from the cablecos, satellite providers and OTT providers for television and Internet market share. Although competition exists within cloud services and the data center space, these industries are growing. Telcos can also integrate their colocation and managed services with their traditional voice, video and Internet offerings, differentiating themselves from other communications providers.

Along with the potential for growth, moving into managed services and data centers will also bring about new challenges for telcos. The cloud services business is technology intensive and evolving rapidly, requiring providers to manage the changes in technology and to adapt quickly to clients needs. Through M&A, the phone companies have acquired the technology and expertise required to provide these cloud-based services, but managing these technologies and the business going forward is the next challenge. However, based on the flurry of M&A activity in 2011 it is a challenge that plenty of telcos are more than willing to take on.  

ILEC to Acquire North Carolina-based Data Center Operator

High Point, North Carolina-based North State Communications announced on December 15th that it has entered into an agreement to acquire Winston Salem-based DataChambers, a data center operator and managed services provider. Financial terms of the deal were not disclosed. With its acquisition, North State becomes the most recent LEC to venture into the data center and managed service space, joining Warwick Valley Telephone (Alteva) and Twin Valley Telephone (ISG Technologies).

DataChambers is a ten year old company that provides data colocation and disaster recovery services for small-to-medium sized businesses within the Triad region (Greensboro, Winston-Salem and High Point) of North Carolina. The company currently operates two data centers in Winston-Salem, encompassing 120k square feet of data storage and disaster recovery space. It has also expressed interest in adding a third data center in order to increase its capacity. DataChambers' current roster of clients includes businesses from a variety of industries, including North State itself.

Upon the deal’s close, DataChambers will operate as a wholly-owned subsidiary of North State and Nick Kottyan will retain his position as ceo of the acquired entity. North State however will not acquire DataChambers’ records management segment, which provides hardcopy paper storage and management for customers.

The deal makes sense for North State on multiple levels. Geographically, North State operates in the same Triad Region of North Carolina that DataChambers calls home, and both companies serve the same business customers. From a competitive standpoint, the acquisition provides North State with a portfolio of business-centric services that it can offer alongside its broadband voice, video and Internet services, differentiating itself from other communications providers in the area. The independent LEC will also be able to cross-sell its existing business customers on DataChambers’ colocation and disaster recovery services, generating incremental revenue in the process. 

Most importantly, the data center/managed services space offers North State the potential for growth. Gartner projects data center spending to reach $99b in 2011, a 12.7% annual increase from 2010, and it forecasts that figure to rise to $127b by 2015. North Carolina in particular has become a hot-bed for data center development—with the likes of Apple and Google spending north of $1.6b to build properties in the state—thanks in part to its cost effective electric grid and relatively cheap land.

Consistent with the strong industry growth, DataChambers has improved its top line significantly over the past three years. The company grew its revenues from $3.5m in 2007 to $6.8m in 2010, expanding at a compound annual growth rate of 26% over that time frame.

While North State has not released details on how much it will pay for DataChambers, we have seen a number of priced data center deals over the past year, allowing us to make some educated estimates on the deal’s price tag. The weighted average revenue multiple for observed data center purchases in 2011 is around 5.4x while the median revenue multiple comes in at 4.3x. Based on these levels, and using DataChambers’ $6.8m revenue in 2010, we derive a price estimate in the range of $30-$36m.

In September, North State attempted to increase the visibility of its business services, rebranding its business segment “North State Business.” It stated that the name change reflects the type of customers that are critical to the LEC’s growth and longevity. The acquisition of DataChambers reinforces this sentiment.