Late this evening 6/26/07, Web.com (WWWW - $5.35) and WebSitePros (WSPI - $10.01) announced plans to merge. Technically, it is WebSitePros buying Web.com with WWWW shareholders having the right to either all stock in WSPI (at a 0.6875 ratio per share) or a portion in cash paid out at $6.52/share for up to $25mn. The board's have approved the deal. This structure finds WSPI issuing 9mn shares, assuming all outstanding Web.com options, and paying $25mn of cash such that Web.com is valued at $129mn, which is a 22% premium to Tuesday's closing price. The deal is expected to close in 2H07. Web.com hasn't traded at this level since 2003!
As a shareholder of WWWW, I am both happy and sad with this merger and we expect the rest of investors to share the same happy/sad reaction. The happy part is seeing a 22% premium awarded to WWWW shares on the takeout, which is marginally above the 52-week high, but is truly the highest level since 2003 for the shares. While the gains since Jeff Stibel became CEO of Web.com on 7/2/05 have been tremendous, the upside here was thought to be far more significant than this level. This is why the deal is a merger (with up to 20% paid in cash) and allows investors to continue pursuing the higher valuation implied by my "upside" statement. For starters, Web.com has over $300mn of NOLs, which in its own right is twice the implied acquisition price of Web.com. Assuming this NOL passes over to WebSitePros (which itself has over $50mn of NOLs), it's a no brainer to take shares in this merger and continue the ride. The other upside opportunity, which could still come to bear, is the patents held by Web.com where a current patent infringement claim against GoDaddy awaits a court date. That line of thought has always concluded with a hope and a prayer that if any of the key patents are actually upheld (such as the template builder for a web site), the value of the company could rise exponentially.
The hesitancy comes from wanting to stick with a combined company that will still have minimal trading volume, remain undiscovered for the most part, and still be battling for a slice of the "massive" SME market opportunity, which both firms have always talked about but barely shown the results that an organic strategy can bring that "opportunity" to bear. Given the acquisitions for scale across all realms of the hosting business, this combination was a no-brainer and as I explain below, it might actually be as good on paper as it can be in practice. However, even at $117mn of annualized revenue on a combined basis, the company has only reclaimed a position in the marketplace (even though not crowded in the mass market hosting segment) as one of those with over $100mn in revenue. HostWay bought Affinity Internet recently to get to this size. Audax/Endurance just bought iPower and approaches that mark and then of course there is GoDaddy, which pulled its IPO a year ago, yet has scale and mass well beyond the size of this combination (even if a lot of that is from domain registration which both Web.com and WebSitePros partner with Register.com to have on their list of goodies - perhaps when Web.com partnered with Register.com in March 2007 we should have seen this merger in the works!).
Given the breadth of the partnerships now shared at this soon to be combined company, perhaps the chance for continued consolidation rises and perhaps the scale and scope of such acquisitions could rise. While possible and likely probable, I still believe that realizing full value out of this investment will need to happen from one of the majors in their current partnership rosters (be it Yahoo, Microsoft, etc) opting to assign a fair value to these businesses relative to the rest of the sector. Short of that, it might take a new public offering of stock in one of the private companies like GoDaddy, Hostway/Affinity, Rackspace, etc to help set the course to greater marketplace attention since neither firm was able to really crack that nut on their own. Consider the following:
- WebSitePros: 19.7mn shares, $10/share stock, $41.5mn of net cash, and a profitable business on track for $70mn in 2007 revenue. This equates to a market cap of $197mn and an enterprise value of $156mn. Since WebSitePros projects a target pro-forma operating margin target of 20-25%, it's hard to think that 2.2x sales or 10x EBITDA is anything close to an overvaluation.
- Web.com: 16.7mn shares, $5.35/share stock (pre-deal), with ~$20mn of net cash, and an about to be profitable business on track for $55-60mn in 2007 revenue. This equates to a market cap of $89mn and an enterprise value of $69mn. This is a 1.3x multiple of sales and assuming Web.com could also attain a 20% pro-forma operating margin would be 6x multiple of EBITDA.
- Therein lies our reason for investing in Web.com instead of WebSitePros, but the reality is that both are undervalued...if they can get the top-line growth needle to move in a meaningful way. Churn is dropping for both companies, organic growth is increasing for both companies, so perhaps I should just shut-up and focus my efforts on cheering them on to greater success towards growth!?!?
Since we gotta figure out how this valuation mystery (to me at least) gets solved, I will continue. Together, the companies have $117mn in run-rate revenues from 234k paid subscribers ($500/sub/year). With WebSitePros issuing 9mn shares of stock plus assumption of options, we can figure the combined company has 30mn shares. Further assuming that the ~$65mn of combined cash balances is reduced by the full $25mn available for cash payout, there will be a market cap of $300mn (based on WSPI closing price on Tuesday) and an enterprise value of $260mn. This is only 2x what the 2007 revenues for the combined company should be. Further, if that $130mn of combined 2007 revenue was achieving the target 20-25% pro-forma operating margin, this would mean the valuation is ~8x EBITDA.
We again go back to whether or not the company can grow the top-line and/or can bring it's profit margin close to the target range. Well, Web.com had already been pitching the idea that another $3.5mn of annual cost savings would be achieved before the end of 2007. We note this because in the announcement of the merger, they call for $5-7mn of cost savings for CY08. If that is in addition to the $3.5mn Web.com said to look for, we have a quicker way to see the light on the margin side of this coin. I will ask this question on the call in the morning. As for the top-line growth side, I can only say that I continue to believe in the opportunity for this sector and now that the company has even more scale, plus the benefit of some nice headwinds driving adoption of their services, that revenue growth will come (even though acquisitions should certainly still be fully pursued).
The biggest reason for my enthusiasm in top-line growth in grounded in the partnerships and channels held on a collective basis. As noted in our opening, it looks really good on paper. WebSitePros is a "do it for me" company while Web.com is a "do it yourself" company. With Microsoft's Office Live service still heavily promoting WebSitePros and Web.com's self-induced uplift in SAC spend starting to gel, coupled with continued strong lead growth from Discover, RH Donnelly (recently renewed at Web.com), and many others, the combo of the DIY and DIFM approaches could really be powerful. Anyone else operating a shared hosting company reading this (especially Hostway and GoDaddy) are likely saying that this statement truly does look better on paper than in practical reality. However, partners of these firms are just now starting to take hold. So, enough about that. I am a believer, but each reader of this needs to grab their own confidence level to believe the possibility of this combination.
As for management, the release says that the CEOs of both companies will be maintained. WebSitePros' CEO David Brown will remain CEO of the combined firm while Web.com CEO Jeff Stibel will assume the role of president, yet remain on the combined company BoD. Including Mr. Stibel, Web.com will have three of the seven BoD seats, so it will be interesting to see who is maintained when the music stops to see which talents are believed to have the best chance of driving the success they seek.
The deal is said to be accretive on a pro-forma basis in CY08 and breakeven on a GAAP basis by 4Q08. For a recap of where each company stands as of 1Q07's reports, here's a recap.
- WebSitePros reported 1Q07 revenue of $16.4mn with $15.2mn from subscription services. GAAP net income of $632k or $0.03/share. Pro-forma net income of $2.4mn up 44% Y/Y or $0.12/share up 33% Y/Y. Cash from operations was $2.2mn and capex was $415k in 1Q07. Subscriber count 76,600. 19.7mn shares. $41.5mn of net cash. They provide guidance for 2007 revenue of $70mn and have a pro-forma operating margin target of 20-25% (58-62% gross margins, S&M expense at 19-21%, R&D at 4-5%, and G&A at 11-13%).
- Web.com reported 1Q07 with revenue of $13mn. Net loss was $1.6mn. Pro-forma loss was $0.2mn. Subscribers were 158k. 16.7mn shares. $16mn of cash plus $7.5mn of restricted investments with $3mn in long-term debt and CLOs. Cash from operations was $1.3mn and capex was $685k.
As for the 21 patents held by Web.com? Perhaps this merger isn't at all a sign of any weakness felt by Web.com in its pursuit of a license by GoDaddy (or any of the next companies on the licensing hit list), but instead a merger to create better scale and scope from which to pursue their legal defense. It's not worth too much text on this now since we will ask this question on the call in the morning.
We already mentioned Web.com CEO Jeff Stibel as having hit a home run in relative terms since taking over the CEO post in August 2005, which the press release noted is a 200% return in his just under 2 years of service. Hard to argue with that. As for his motivations to stay on board (which we hope and expect he will), he stands to get $350k of cash if he is terminated before the six month anniversary date of the closing, which would likely be around the start of 2Q08. He might have other incentives, but his biggest one is sure to be his 13.5% stake in Web.com. He individually actually owns more than the largest fund invested in the company, which is PAR Investment Partners with their 11.9% stake followed by Dimensional Fund Advisors with 7.4%, Kinderhook Partners with 7% and then Web.com's chairman owning 5.6% under a holding company of his initials with 5.6%. Since WebSitePros has one last remaining VC (Norwest) still with 50% of their initial investment held in WSPI shares, it is possible that a secondary offering of those shares could be made along with some new shares to bolster the balance sheet to pursue acquisitions post the deal closing as a means of removing a lid from WSPIs illiquid stock and helping to create better liquidity for the combined company. I plan on asking this question on the call, but don't expect much of an answer on this one since the deal is only a few hours past announcement stage.
My biggest question remains confirming the NOL being maintained. To use specifics, Web.com reports having $317mn of federal tax loss carryforwards in their 2006 10K while WebSitePros reports $50.6mn of NOLs ending 2006 in their 10K. This kind of tax benefit will truly allow the company to grow wildly (if it's possible) and have most every profit dollar for the next few years fall to the bank account.
For those interested in listening to the call, it begins at 815am EST on 800-811-8824 with password 1284757. Replay 888-203-1112.
