WorldCom Muscles in on Web Hosting

Worldcom's purchase of Intermedia's subsidiary Digex will help it ramp up in the fast-growing Web hosting business as the company continues to transition toward business data services and away from consumer voice. Digex brings an impressive customer list and substantial value-added services to the deal, while Worldcom brings global marketing capabilities.

By Chris Rugaber (TMF RFK)
September 5, 2000

As reported in this morning's Breakfast News, interexchange carrier Worldcom (Nasdaq: WCOM) purchased competitive local exchange carrier (CLEC) Intermedia Communications (Nasdaq: ICIX) to gain ownership of Intermedia's Web-hosting subsidiary Digex (Nasdaq: DIGX). The transaction is expected to close early next year.

In response, Intermedia's shares jumped some 40% in heavy midday trading thanks to the premium WorldCom is offering for the company. Digex shares have fallen more than 12%, to $73 7/8, in part because WorldCom has made clear, contrary to earlier expectations, that it is not planning to buy the shares of Digex that Intermedia doesn't own. Instead, WorldCom will own 55% of Digex and gain 94% voting control, and Digex will remain a publicly traded company. WorldCom 's shares were down about 8%, due in part to concerns over short-term profit dilution, according to Bloomberg.

Worldcom evolves
Today's transaction is a manifestation of WorldCom's continuing shift in focus to data and Internet services and away from its consumer voice business, which it is likely to dump one way or another in the next few months. While the company remains the nation's number-two long-distance carrier, such a moniker will become less and less useful as the company moves into the kind of Internet services that Digex provides.

"generation d"
As part of the company's so-called "generation d" initiative, WorldCom is already expanding its Internet services by spending $1 billion to build 120 Web-hosting centers. Nevertheless, according to WorldCom CEO Bernie Ebbers, the company's purchase of Digex "accelerates by 12 to 18 months our ability to provide world-class managed Web and application hosting services -- one of the highest growth markets in the industry."

Indeed, Web-hosting is a hot market right now. Prudential Securities expects it to grow at a 75% annual rate through 2004, from a $1.8 billion business in 1999 to $29.5 billion in 2004. Ebbers used different but still impressive figures in a conference call today, pegging the business at about $2.5 billion now and predicting it will reach $17 billion by 2004.

As a result, it's not surprising that larger telecom companies want in, and WorldCom's not the only one. In fact, Japan's NTT (NYSE: NTT) recently purchased Web-hosting firm Verio (Nasdaq: VRIO), and AT&T (NYSE: T) inked a deal today with IBM (NYSE: IBM) to provide the computer services company with Web-hosting facilities.

What makes Digex different?
Certainly one of the things that made Digex so attractive to WorldCom and other suitors is that it does more than simply provide basic "colocation" services for a company's website, as many of its competitors do. Instead, Digex provides comprehensive services that enable companies to outsource most of their Web and e-commerce operations, and it also provides hosting for application service providers. These more complex services earn higher-margin, recurring revenue.

Digex also brings an excellent customer list to the deal, including Sony, Capital One Financial, J.P. Morgan, Nokia, Freddie Mac, and Ford Motors. As this list indicates, Digex's customers are more likely to be large- and mid-sized enterprises, rather than just "dot coms," which are accounting for a decreasing proportion of the company's revenues.

Speaking of revenues, Digex's are exploding. Second-quarter sales were up 195% from the previous year, to $37.2 million. Revenues were projected to reach $165 million in 2000 and $300 million in 2001, prior to today's announcement.

Of course, this would not make much of an impact on WorldCom 's 1999 sales of $37 billion anytime soon, but the company plans to dedicate its worldwide sales force to selling Digex's services to its current customers, as well as to new ones. As a result, Worldcom expects the acquisition to be accretive to earnings by the end of 2002 or early 2003. All in all, given the hyper-growth of this industry, and the other parties interested in Digex, WorldCom's move today looks like a good one.

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Related Links:
Worldcom Takes Control of Digex, Breakfast News, 9/5/00
Worldcom at the Crossroads, Fool News, 7/27/00

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