Andy Schroepfer

NaviSite (NAVI - $7.02) announced another acquisition this morning with a $40.5mn purchase of privately held NetASPx (pronounced net-aspects). This is certainly on the large end of the deal size spectrum for the company, yet does have similar traits to the entirety of the past deal history of NaviSite, which was very active in the early part of the decade, fell asleep for a few years and now appears to be back with avenagance. As I will explain, this deal makes great financial sense, makes solid strategic sense, and yet the stock market seems determined to not care about the value of the company.

On the strategic front, I have written previously about how NaviSite runs the largest managed /hosted partner practice of Microsoft's applications (outside of Exchange) due to the acquisition of Surebridge. Similarly, NaviSite has one of the larger application management services practices for the JD Edwards/Peoplesoft applications from Oracle. I mention these because having scale with those applications makes the company important. Now, the acquisition of NetASPx expands this list of supported applications into both Lawson's ERP (where NetASPx is the largest managed services partner of Lawson) and Kronos' workforce management and business intelligence apps. This has helped to more fully round out the key applications on the marketplace as part of the core service offering fabric of NaviSite. It sounds like most of NetASPx's $20mn in annualized revenue comes from Lawson, but there is likely very some very solid upside for cross-selling in the Kronos application to NaviSite's installed base.

On the financial front, Navite is paying a mere 2x sales and a mere 5x EBITDA for NetASPx. For context, Navisite has a market cap of $225mn and an enterprise value of $345mn following these latest three acquisitions. The company also now should be on track for $170-175mn in FY08 (ending July 2008) revenue and $40-45mn in EBITDA. This puts NaviSite at an EV/S multiple of 2x and a EV/EBITDA multiple of 8.1x (using the mid-points). This means NaviSite purchased a business below it's own valuation, which is a key ingredient to a successful valuation outcome for the acquirer.

So, why does a acquisition that makes strategic and financial sense that has some size significance to the acquirer get greeted poorly by the stock market? First, the markets are looking for international growth and since NetASPx increases the revenue mix toward U.S.-based revenue, this deal doesn't feed the markets what it wants to eat right now. Second, with the exception of IBM, the consulting and IT services group (especially the offshore providers) have been in meaningful valuation decline (due to the appreciation of the rupee in India), so as NaviSite grews its application services business it too reflects that declining valuation reality. Third, the deal terms to finance the purchase of NetASPx includes a PIX component. On this last note, we believe this is just a temporary financing means while the credit markets are in turmoil, so look for the company to refinance that $25mn component of the deal before the 18 month term on the convertible preferred debt matures. I could go into how much larger a multiple that all of the other Internet Infrastructure Services firms trade at to explain why NaviSite's stock could double from here just to trade near/at those same multiples. Instead, I will go deeper into the raw value inherent in this latest acquisition and expect that in time the markets will realize NaviSite's now even more sizable stature and value (relative and absolute).

NetASPx is a Virginia-based company, but runs its business from a data center in Minneapolis, MN that is 18,000 net square feet. Why Minnesota? Well, Lawson is based in Minnesota too (nuff said). Until recently, the company has a 30% customer in the Department of Defense, which cancelled due to reasons not related to service quality or pricing. Of note, the $20mn revenue and $8mn EBITDA assumptions for NetASPx fully take this DoD client loss into consideration. As that infrastructure is removed from the data center, this leaves NetASPx with 15% of the 18,000 square feet in operation. This is where the press release's mention of revenue per square foot at NetASPx of $8,000 is derived ($20mn/year divided by 2,700 utilized square feet). Using that same $20mn revenue number divided by the press release's mention of ARPU/mo being $19k, we can assume that NetASPx's client base numbered around 85-90 (even though the bio for Director of Sales Paul Cioni mentions having 140; sales collateral mentions the firm having served over 150 clients).

Clients mentioned in various web site mentions include: Drive Financial, Great Plains Coca Cola, Magellan Health Services, Sovereign Bank, TeamStaff, Binney & Smith, Grocers Supply Co, Feld Entertainment, Wisconsin School District, El Pollo Loco.

From my digging today, I heard the data center in use is under a 3 year lease with no renewal option. While the facility is very under utilized, I believe either this can be sustained and leveraged for new customer adds (especially if rumors prove true that IBM is about to buy Lawson, which I believe will happen). I believe the company could transfer the lease to another party  if they wanted to migrate the customer base, but I dont believe that will be a course of direction taken. The facility uses water-based cooling instead of forced air cooling and is largely a "supercomputer" facility managed by 30-somethings instead of 20-somethings. Suffice to say, the firm is managed by professionals who have been in the business for a decade or more and operate in a facility deemed by many to be fully capable already (note-ably with minimal maintenance capex required for Navisite).

NaviSite should be acquired, but seems more than happy to beef itself up until the stock market at least values the firm more closely to the peer group. The expanding portfolio of applications supported by NaviSite would prove incrementally interesting to an offshore player (a la Wipro buying Infocrossing) or a global IT service provider (like IBM, which noteably was named earlier this summer as the hosting partner for Lawson's direct efforts) or even the major telco's who push IT like Verizon and AT&T. This will work out in the end, especially if Navisite provides solid guidance on 9/25 when it reports 4QF07 results to account for the great stategic moves I believe deals like this one demostrate.