Hosting is in my blood.
I can thank my six years at Peer 1 for that.
It was a period of high growth for the company. Existing customers were spending more. Larger, new customers were being added. Competitive products were being launched faster. And the customer service experience was at an all time high.
So, why was I still so damn worried all the time?
It gets back to basics. No matter how fast an organization is growing or how successful it is on one (or several) front, its long-term viability boils down to how efficiently cash flows IN and cash flows OUT of the business. In my case, I was obsessed with establishing and maintaining a healthy EBITDA margin quarter-over-quarter, year-over-year. Top-line revenue could be at an all-time high, but if it coincided with a drop in EBITDA, I sweated. Same with our return on capital (ROC) with hosting being such a capex-heavy business.
In this industry, EBITDA drives valuation and determines the amount of cash flow being generated from operations that can be re-invested back into the business. Consistently increasing revenue, maximizing EBITDA and optimizing capex remain key to maximizing shareholders’ value.
Peer 1 wasn’t any different. Its EBITDA was the main determinant in it’s overall valuation. The final purchase price to Cogeco Cable of $526 million back in January represented a 12.1X EBITDA, or a healthy 32 percent premium over Peer 1’s 20-day volume weighted average share price. Our strict management of EBITDA eventually paid off.
I finally stopped sweating.
Cloud Changed Everything
It was during my time at Peer 1, that I experienced just how rapidly the the hosting landscape was changing.
After years of them being simply a rumour, suddenly we found ourselves competing with Amazon Web Services (AWS) on our dedicated hosting offerings. Soon after, we were competing with them AND Rackspace Cloud on some of our managed hosting solutions. It became clear that this was less of a short-term market fascination with cloud computing–or water vapor–and more so a movement that would force smaller hosting providers to forever change the way they operate. The time had come to start treating servers like cows and not puppies to survive in this new era.
Today, cloud is the fastest growing segment in the industry. Worldwide cloud revenues alone are forecasted to grow from $55 billion to a staggering $95 billion over the next three years (source: Parallels Global SMB Insights 2013). Industry-related headlines have leaped their way into mainstream media, riding Wall Street’s feverish interest in cloud technology that’s moved from ecstatic to panic (and back). If you are following Rackspace (RAX) trading on the NYSE, you know exactly what I mean. The 52-week price range for RAX is wild: $33.91 to $81.36. Shares dropped over 6 percent on July 10th with the AWS price cut announcement. It dropped again this week with the anticipation of missing Q2 targets, only to jump sharply in after-hours trading yesterday on news the company had, in fact, beat expectations.
With the few heavyweights snatching much of the spotlight, it may come as a surprise to some at how fragmented the industry actually is. Approximately 35,000 hosting companies operate worldwide with 10,000 in North America alone. Over 80 percent are smallish, boutique hosting providers generating under $100 million in annual revenues–with the vast majority less than $20 million. As AWS ploughs its way through the race to the bottom on cloud prices, a boutique hosting provider must make a choice–do you want to control your own fate or leave it to chance? If it’s the latter, then chances are… well, not so good.
For everyone else, there is plenty of opportunity to optimize your current spending levels to improve and protect EBITDA (as well as ROC), while freeing up monies to fund value-creation initiatives. You can start with your largest capital expenditure–servers. DCIM software is available to help small hosting providers control their IT asset spend through inventory management and capacity planning, while gaining visibility into their data center. Choosing to standardize servers and using high density technology significantly reduces related operating costs and power consumption. And reverse logistics services are available to help you recoup maximum value from your legacy equipment.
Optimizing current spending and investing more in innovation allows the boutique hosting provider to compete, protect prices and be profitable in the face of ongoing pricing pressures. It also maximizes the company’s valuation as a multiple of EBITDA–if you have your sight set on eventually being acquired.
More Consolidation Coming
IBM’s $2 billion acquisition of privately-held Softlayer is just the latest in a string of high profile moves. Earlier in the year, Cogeco Cable Inc. acquired Peer 1. In 2011, Century Link acquired Savvis for $2.5 billion–the same year Verizon acquired Terremark for $1.4 billion and Time Warner Cable acquired Navisite for $230 million. Along the way, there have been countless numbers of investor groups picking up smaller hosting and cloud providers. I expect this kind of activity to only accelerate in the years ahead.
If your end-goal or exit strategy is to be acquired, then now is the right time to get aggressive on maximizing your company’s value. Start by cutting costs.