Entries in Managed Services (3)


Telcos Take to the Cloud in 2011

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.  


Twin Valley Telephone Eyes Growth in the Cloud

Independent Telco Sees Growth Potential in Managed Services

On November 1st, Miltonvale, Kansas-based Twin Valley Telephone Company (TVT) announced that it had acquired a majority stake in cloud services provider, Salina, Kansas-based ISG Technologies. While financial terms of the deal have not been disclosed, the combined company will generate around $90m per year. The purchase signals a pivot for TVT to target more small to medium-sized business customers—a shift that many telcos and communications providers of all types are making. With the increased competition in managed services, the question remains: Who is best positioned for success?  

An independent, family-owned telephone company, Twin Valley has provided telecommunications services to customers since 1947, with its company’s roots dating back to 1900. It currently serves 6.6k subscribers and 7.4k access lines over a footprint of 2.4k square miles in north-central Kansas. The telco completed a fiber build over its entire footprint in 2009, and offers IPTV, and broadband Internet in addition to its phone services.

As a competitive telco for over 60 years, Twin Valley has gone through many transformations in its day. It got into the cable television business in 1983, and amid increasing access line losses in the 1990’s and early 2000’s it turned to IPTV as a revenue replacement growth strategy in 2003. In March 2006, it nearly tripled its size, purchasing 5,200 access lines in 13 Kansas exchanges from Sprint.

In acquiring ISG Technologies, TVT adds a portfolio of managed services and data center solutions along with an established based of 2,500 SMB clients. While the term “cloud services company” can conjure up the image of a crew of 5 to 10 people operating out of a basement somewhere, ISG is an experienced IT company with 28 years in the business and 140 employees. Like many IT companies, ISG has found a niche in “cloud services”—which it admits is essentially a metaphor for utilizing the Internet for your computing and communications needs.

Twin Valley had its own experiences in “the cloud” which led to its interest in ISG. According to ceo Ben Foster, TVT realized the potential of selling cloud services after the company itself moved over to a virtualized server infrastructure.

“Our realization that a business-focused cloud strategy was going to be our growth opportunity outside of our footprint occurred just after we went to a virtualized server infrastructure.  We began to save significant amounts of money by reducing the number of servers that vendors were selling us and charging us to maintain. It became evident that what we really had was a mini-data center that could be leveraged to sell hosted services and disaster recovery.”

TVT experienced first hand the economic benefit that cloud services could provide to small businesses, and saw a potential revenue stream for its own business. It decided to offer services such as web hosting and disaster recovery, which it offers along with its hosted VoIP services. With the ASG acquisition, TVT is doubling down on the cloud. 

TVT however is not alone. In addition to regional telcos like Warwick Valley Telephone (Alteva) and TVT moving into managed services, massive corporations like Amazon and Google are getting into the same space. Best Buy just acquired IT services firm mindSHIFT for $167m, commenting that the combined companies are looking to capture a greater share of the $40b small and mid-sized business MSP market.  While bigger doesn’t necessarily mean better, a company like Best Buy, armed with its strong distribution channels and Geek Squad service expertise appears to be well positioned for success as an MSP. 

Despite the growing competition, Foster believes there is plenty of room on the cloud for the giant companies and smaller providers alike. Specifically, he feels Twin Valley and ISG are better suited to provide quality service that meets the business needs of small to mid-sized companies.

“In our market research, we identified a gap in the type of support these corporations provide business customers versus what they expect for the investment they are making.  If you are a fellow Fortune 500 company, Amazon and Google would be happy and probably better-equipped to support you.  If your company is smaller than that, you aren’t really hitting their radar screen.  Companies of all sizes can’t operate without an efficient, capable IT partner and infrastructure. We are far better equipped to handle that next tier of companies’ needs and will do so aggressively.”  

That LECs are competing in similar areas to an Internet search giant like Google, and retail companies like Best Buy lends more credence to what we already know: the telecommunications landscape is changing rapidly, and media providers of all shapes and sizes are a part of this giant shake up. 

As this convergence in telecommunications is taking place, some providers are content to maintain a strategy that has worked for them for years--focusing on their core businesses: telephone, cable television, and Internet. Others are taking a more proactive approach to their future. With its acquisition of ISG Technologies and its move to the cloud, Twin Valley is proving that it is the latter.


Verizon Set to Acquire Terremark Worldwide for $2b

Verizon Joins List of Telcos Reaching for the Cloud

After the close of the market on January 27, 2011, Verizon Communications (NYSE:VZ) announced on that it had entered into a definitive agreement to acquire Terremark Worldwide (Nasdaq:TMRK).  The transaction values Terremark at approximately $2b, including $1.4b for the company’s net equity and $600m of assumed debt.  Verizon will pay Terremark shareholders $19 per share, which represents a 35% premium over Terremark’s closing share price on the date of the announcement.

Verizon anticipates commencing a tender offer for Terremark’s outstanding common stock between February 10, 2011 and February 17, 2011.   The transaction is subject to the tender of a majority of Terremark’s outstanding shares.  Verizon has already entered into agreements with three of Terremark’s shareholders – Cyrte Investments GP I BV, Sun Equity Assets Limited and VMware Bermuda Limited - to tender their shares, representing approximately 27.6% of the outstanding voting shares of the company.  Verizon expects to close the tender offer late in 1Q11.

Terremark is a global provider of managed IT solutions leveraging a network of highly connected carrier-neutral data centers across major networking hubs in the United States, Europe and Latin America.  The company delivers a suite of managed solutions including colocation, managed hosting, managed network, disaster recovery, security and cloud computing services.  Terremark serves approximately 1,400 customers worldwide across a broad range of sectors, including enterprise, government agencies, systems integrators, network service providers, internet content and portal companies and internet infrastructure companies.  The company delivers its solutions through 13 specialized data centers, including its three primary facilities: NAP of the Americas in Miami, Florida; NAP of the Capital Region in Culpeper, Virginia outside of Washington, D.C.; and NAP of the Americas/West in Santa Clara, California.

For Verizon, the transaction is all about soaring higher into the clouds and, in our opinion, locking up one of the larger independent cloud computing/managed services providers before someone else does.  Verizon already has a significant presence in the data center sector, operating 220 data centers across 23 countries, including 19 “premium” and five “smart” centers.  Verizon is transforming to a cloud-based “everything-as-a-service” delivery model with the objective of putting the power of enterprise-grade solutions within the reach of every business, wherever and whenever needed.  “Cloud computing continues to fundamentally alter the way enterprises procure, deploy and manage IT resources,” said Verizon president and ceo Lowell McAdam.  The acquisition of Terremark “helps create a tipping point for [our] ‘everything-as-a-service’ [initiative].”

For Terremark, it looks like Verizon simply made an offer they could not refuse.  According to Manuel Medina, Terremark chairman and ceo, the transaction is “first and foremost” about providing their shareholders with “immediate, maximum value and liquidity for their investment.”  Having taken care of his investors, Medina notes Terremark’s affiliation with Verizon presents an “exciting opportunity to accelerate our strategy and serve enterprise and government customers with even greater innovation on a global scale.”  Verizon intends to operate Terremark as a wholly-owned subsidiary, retaining the company’s name and management team.

The Terremark transaction adds to a growing list of telecom players announcing acquisitions of data center and managed services providers.  Telephone and Data Systems (NYSE:TDS) announced on December 15, 2010 that it had acquired TEAM Technologies for $47m.  The transaction followed TDS’ previous acquisition of Visi.  On December 1, 2010, Windstream (NYSE:WIN) completed its $310m acquisition of Hosted Solutions.  And back in June 2010, Cincinnati Bell spent $525m to acquire CyrusOne.

Terremark expects to generate revenue of $352m for the fiscal year ended March 31, 2011, up from $292m for the year ended March 31, 2010.  Since 2008, Terremark has been increasing revenue at a compound annual rate of 27%.  Based on operating results for the quarter ended September 30, 2010, Terremark generated annualized OIBDA and operating income of $77m and $25m, respectively.  Despite its impressive top-line growth, Terremark posted an $18m loss for the six months ended September 30, 2010, due primarily to carrying costs on the company’s $600m of debt.  For the three fiscal years ended March 31, 2010, Terremark posted cumulative net losses of $84.5m, $43.8m of which were attributable to losses on the early extinguishment of debt and losses as a result of changes in the value of derivatives.  Now that Verizon’s financial resources have been brought to bear, the management resources necessary to continue to fund Terremark’s losses can be refocused towards accelerating operating growth.

The cloud is hot and that no doubt contributes to the high price Verizon is paying for Terremark.  Before expected synergies, the transaction implies a multiple of FY2011 projected revenue of 5.4x and a multiple of LQA OIBDA of 24.7x.  Adjusting for synergies, which Verizon estimates have a present value of $500m and are driven by opportunities to increase revenues, decrease expenses and save on capital expenditures, the multiples fall to 4.3x revenue and 19.5x OIBDA.  We have attributed $100m of Verizon's expected $500m of synergies to the estimated net present value of the future tax shield resulting from Terremark's $320m of available net operating loss carryforwards.