01/04 - Tier 1 Research Report: VeriCenter Confirms and Closes Acquisition of Large Portion of Sprint's Hosting Assets

VeriCenter, a privately held provider of managed hosting services, confirmed its acquisition of certain Sprint [FON] hosting assets and customers. Specifically, VeriCenter is acquiring: 1) four of Sprint's data centers (Boston, Atlanta, Dallas, and Denver); 2) a large segment of Sprint's E|Solutions managed hosting clients; and 3) the DellHost operations, which Sprint ran for the past two years. All together, VeriCenter says the acquired revenues bring its annualized revenue stream to $45m and more importantly catapult the company onto the national scene for managed hosting services. Transaction price was not disclosed, but T1R estimates it was minimal, such that the $10mn of new funding raised will go toward working capital for growth and expansion.

Elevates VeriCenter to National Scene: VeriCenter has grown its business successfully in the Houston market since opening its 13k SqFt IDC in June of 2000. With the acquisition, VeriCenter will operate in five major markets as a national provider. T1R would expect the company to now compete much more effectively with such firms as: Data Return, Inflow, MCI/Digex, NaviSite, and Rackspace.

New Funding for Stature Not Sustenance: In conjunction with the transaction, VeriCenter raised $10mn in a Series D financing (led by Sage Venture Partners). Management told T1R that that the funding was not required, but was a key in helping give Sprint the confidence to award VeriCenter the transaction. VeriCenter does have $5mn in debt, but now has an estimated $15mn of cash and the business is said to still be cash flow positive following the transaction, a level VeriCenter achieved on its own since February of 2002.

Eliminates Some of the "Up for Grabs" Market Share: The announcements of exiting hosting by both C&W and Sprint (a combined $460mn per year in hosting revenue) gave the competitors a lot to be excited for in terms of grabbing market share from existing industry clients. The closing of the transaction, coupled with Equinix's buy of the Sprint Santa Clara facility and customers, means roughly 55% of Sprint's $60mn in hosting revenue is spoken for. T1R estimates another $10mn of Sprint's hosting revenue remains in non-acquired Sprint IDCs following this deal.

When a $7 billion dollar fragmented industry consolidates, there emerges great opportunity for companies such as VeriCenter. The acquisition of the assets from Sprint is a great example of the company taking advantage of this opportunity. The transaction catapults VeriCenter from a regional to a national player positioning them squarely against the top tier of managed hosting providers behind IBM [IBM], EDS [EDS], and AT&T [T]. T1R was impressed to learn of the customer details for VeriCenter post this acquisition. From our briefing with management, we learned that roughly 85% of its run-rate revenues are from enterprise class hosting accounts. The numbers work out to roughly $38mn annually from a little over 400 customers, which equates to roughly $93k/year/customer. VeriCenter said that its typical client is having VeriCenter manage 4-6 servers with many clients having the company manage database clusters, SAN storage environments, and load balancers. There is even less information available on the DellHost acquisition, but management was certain to express that there are some high quality and sizable customers in the DellHost business.

T1R also learned that the company has a handful of accounts with upwards of 40-50 servers under management on the higher-end following the transaction. One such larger client that has been in the news recently is NASA's site for the MARS landing over the holidays. T1R referred to this deal in our newsletter recently with respect to Speedera, the privately held CDN provider delivering the downloads and offloading the massive traffic hitting the site, which is hosted with VeriCenter (formerly Sprint). All told, from a peek at VeriCenter's customer list, we saw a high quality list of major enterprises and government accounts as well as some unique ASP businesses within several leading global systems integrators such as Accenture, PwC, and E&Y.

Whether or not VeriCenter paid a lot or nothing at all for the assets acquired in the transaction, we first questioned the company as to why four sites were chosen and why those four. The answer was simple...these were the sites with the highest revenues and the lowest costs. While Sprint purchased most all of the required environment equipment for each of the ten IDC it built, none of the sites were fully facilitated. Accordingly, there will be some capex involved for VeriCenter when demand drives the need to enable the space acquired. On a gross square foot basis, the four sites bring a total roughly 400k SqFt to VeriCenter (96k in Atlanta, 75k in Boston, 75k in Dallas, and 150k in Denver). T1R believes it is fair to assume that 20k SqFt in each of these sites is the facilitated net square feet currently available for customer installations. This would mean that VeriCenter now has about 90k NetSqFt of readily available floor space across its five market locations. T1R will be using an estimated utilization rate on this 90k SqFt of approximately 15%. The company estimates having revenue generating potential for its services in this new footprint (when fully built out) of $250mn per year. Of note, VeriCenter was unable to confirm whether Sprint PCS would remain the anchor client in the Boston facility, but T1R believes it is now highly possible.
This is not the first acquisition for VeriCenter, and is actually its third. The first acquisition was of a neighborhood competitor that went out of business Solid Systems. This maybe added $0.5-1.0mn of annual revenue to VeriCenter. The second acquisition was a small one with a local systems integrator that had some hosting business VeriCenter was able to acquire. This would have been a few hundred thousand dollars at best. Now, VeriCenter is gobbling up a collection of assets that is several times its size, but the leg work on preparing for the acquisition seems to have been significant, such that the company is ready for the challenge and for the growth opportunities that lie ahead. Of note, the company did confirm that it will be bringing in alternate carriers to Sprint to provide connectivity options - a very smart move.

In an effort to bolster its financial situation to win the bid, VeriCenter also closed a $10mn Series D financing (led by Sage Venture Partners), which brings the company's funding to date to $30mn. Sage and the company's seed investor (Broadband Venture Partners) are the two holding board seats. The company also has $5mn in debt, but has been EBITDA positive since August 2001 and cash flow positive since February 2002. The company was one of the first to become profitable in the hosting world and says that each of the sites acquired will individually be positive bottom-line contributors such that the entire company will remain cash flow positive. The company will have 200 employees following the transaction, which works out to an average of $225k/year/employee. It was not disclosed how many of these are joining from Sprint. We do note, however, that the management team at VeriCenter, led by CEO Gray Hall, will remain in tact.

Finally, as for the impact of this transaction on the industry, it does bring about the re-emergence of a sizable revenue generating company to the national scene in managed hosting. To VeriCenter's credit, it does sound as if the revenues being acquired will be fairly solid and maintained without churn of meaningful size. While a great thing for VeriCenter, it is a negative for the sector since many companies have been drooling at the opportunity to steal revenues and market share away from Sprint as it has been trying to close its exit from the hosting business. The announcements of exiting hosting by both C&W and Sprint (a combined $460mn per year in hosting revenue) gave the competitors a lot to be excited for in terms of grabbing market share. The closing of the transaction, coupled with Equinix's buy of the Sprint Santa Clara facility and customers, means roughly 55% of Sprint's $60mn in hosting revenue is spoken for. T1R estimates another $10mn of Sprint's hosting revenue remains in non-acquired Sprint IDCs following this deal. It is unclear whether the remaining three data centers of its original ten (Sacramento, Los Angeles, and New York) are involved in active bids or not, but we believe Sprint's current goal is to be rid of these remaining sites and have handled the last customer transitions by the end of 1Q04.