Web Hosting Interview - Cheval Capital May 2009

May 2009
Web Hosting Interview - Cheval Capital May 2009

Frank Stiff, President of Cheval Capital

Cheval Capital is a boutique investment bank that specializes in mergers, acquisitions and corporate finance, and also holds the title of a leading intermediary in web hosting. The company has helped its clients complete more than 140 hosting and ISP transactions since its start in industry in the late 1990s, and this figure includes 28 transactions in 2008 alone. They have worked on some of the largest deals in the business and clients have included Endurance, Rackspace, Verio, and many other smaller companies. The bottom line is, if things go wrong, Cheval Capital are the people to call. We caught up with Frank Stiff, President of Cheval Capital and find out the truth about the global downturn as far as web hosts are concerned.

  • HOSTSEARCH: Frank, Thank you very much for meeting us like this.
    FRANK STIFF: We're happy to do it, thanks.
  • HOSTSEARCH: First of all, why don't you tell our visitors a little about yourself and your role at Cheval Capital?
    FRANK STIFF: Cheval is made up of myself and Hillary Stiff.  We specialize in helping companies buy or sell hosting and related internet services companies.  We got started in hosting in 1996 with Verio (yes, we're dinosaurs.)  We've really been very fortunate over the years to have worked with a lot of great companies and been able to successfully complete over 140 hosting, ISP and related transactions.
  • HOSTSEARCH: I have never heard this term before, what separates a boutique investment bank from a regular bank?
    FRANK STIFF: Size and scope of service.  We're small and our business is limited to mostly mergers and acquisitions along with some financial advisory services.  Hence we are a boutique.  A regular, full-service investment bank has a lot of other businesses like brokerage, public financings, etc.  Investment banks are also different than commercial banks or savings banks.  Commercial banks and savings banks are what most people think of as a bank, they take deposits and make loans.  An example of an Investment bank is Goldman Sachs.
  • HOSTSEARCH: Just to get this clear, does Cheval Capital focus only on web hosting and IT companies or do you deal with a range of industries.
    FRANK STIFF: Mostly hosting and related fields although we still work in other areas like telecom services and in the past we have worked extensively in other businesses.
  • HOSTSEARCH: And I see from your web site that the company offers services for buyers and sellers, financing services and advisory services. Why don't you talk us through all of these in laymen's terms?
    FRANK STIFF: The basic point in all of what we do is that our big value-add is the experience we have from successfully completing so many transactions in the industry as well as the much larger number of companies that we've looked at in one capacity or another.  More specifically, here is a summary of our main services;

    - Services to buyers and sellers.  This is what we do to help a client buy or sell a business.  This is roughly a three stage process.  The first is the prep phase where we help the client come up with the best strategy for buying or selling the business, prepare for the process itself and, in the case of sellers, help the client put its best foot forward.  The second stage is the offering stage where we introduce suitable prospects, run the process to find the desired buyer or seller, help organize the best way to complete the purchase or sale and assist in negotiating terms.  The last stage is the closing phase where we work to resolve issues that come up and help get the deal closed.  Our big value-add is the experience we have from successfully completing so many transactions in the industry.

    - Financing services are about helping raise money.  While this has not been a focus recently, we have a long track record of raising private equity and debt from professional investors.  We are also a licensed Broker-Dealer which enables us to do securities transactions.

    - Advisory services are about providing financial and strategic advice to companies.  This can include helping put together business plans, launch new lines of business, prepare for IPO’s and a wide variety of other possible things.
  • HOSTSEARCH: So you have been an investment banker for two decades. What have been the biggest deals you have been involved within the period?
    FRANK STIFF: Overall, it was probably the Nextel IPO and all the financings we were involved with leading up to it.  In hosting, the iPowerWeb merger with The Endurance International Group and the $100 million DigitalNation acquisition by Verio come to mind.
  • HOSTSEARCH: And what would you say has been the biggest change as far as the business operates today when compared to 20 years ago?
    FRANK STIFF: From a transaction standpoint, the logistics of completing transactions are a lot easier today thanks largely to technology on all levels.  

    What hasn't changed is the difficulty in valuing companies and working out how to organize the structure of a deal so that the risks are shared between the buyer and seller in a mutually agreeable way.
  • HOSTSEARCH: And clearly, web hosts and related businesses are currently facing stiff challenges with the economy. What's the reality? I have heard that web hosts have a built in cushion, while others have told me they see web hosts really suffering. Who's right? What has been the impact?
    FRANK STIFF: Both are probably right to some extent.  Web hosting for the most part is a recurring revenue business, with strong cash flow margins and generally low levels of debt.  As such, I don't expect there to be the problems in hosting that we're seeing in other industries.   Having said that, growth is certainly down and customer attrition is up so it is no walk in the park.  Some companies are also probably suffering more than others.

    The datacenter/co-location business may be an exception to my comments above as there seems to be a lot more debt in this segment of the business and we've heard more stories of severe difficulty.
  • HOSTSEARCH: Are more hosts selling up?
    FRANK STIFF: No, not really.  We are seeing a lot of buyer demand at good prices for shared hosters.  (Ironically, this could be one of the better times to sell a shared hosting business.)  Among dedicated and managed hosters we have seen a drop in the number of buyers but prices don't seem to have moved downward as yet.
  • HOSTSEARCH: What's your advice to someone who might be thinking of selling a web hosting business? What's the right way to go about it?
    FRANK STIFF: When you go to sell, the first three things you have to do are (1) decide whether to hire a banker/broker (like us) to help you; (2) hire an attorney (we strongly recommend having a good attorney to ensure you are protected if something goes wrong); and (3) produce the information about your business that prospective buyers will want to see.

    Hopefully, you'll have the opportunity to plan ahead for these decisions.  Even if you're thinking about selling in a year or two it is not too early to start researching and talking with the various industry bankers/brokers and attorney's.  

    We'd also suggest that you research and understand how the sale process works and the typical valuations for companies like yours.  There is a lot of good material on the internet and we have a series of posts up on our website that may be helpful.
  • HOSTSEARCH: I can imagine that people might not want to sell something they have invested a lot of time into. What signs are there, if any, that it's time to let go and sell? What should people be looking out for?
    FRANK STIFF: If you're enjoying yourself, making decent money and the business is healthy then it probably does not make sense for you to sell unless you have a better opportunity.  If however, you're burnt out, not pulling out a decent profit or the business is starting to go downhill then a sale could make sense.
  • HOSTSEARCH: Your services include debt financing. Isn't this a high risk area at the moment? How do you balance the risk when assessing a company?
    FRANK STIFF: Debt does add operating risk to a company and when a company is sold, the debt has to be repaid and so it reduces the owner's take.  I'm sure all owners would prefer to build their business without using any debt but for some it is the only source of financing they can get (particularly lease debt.)

    Our advice for those thinking about taking on regular or lease debt is to ensure that the cost isn’t too high (including interest and other hidden costs) and that the payments are well below your free cash flow.  It also makes sense to consider whether the business you’re pursuing is worth it when you factor in the extra costs of the debt.
  • HOSTSEARCH: What about the future? The only thing I see right now is the US government bailing out industries that are bound to fail and increasing the liquidity of banks that seem to be holding on the money. Is that a fair assessment?
    FRANK STIFF: The government is trying to shorten the time it takes for the economy to recover from the bursting of the debt bubble and to minimize the pain for those affected.  I think these goals are appropriate but I would agree that some of their decisions have come with negatives. The only thing I'm sure of is that I'm glad I'm not the one having to make the decisions.

    Despite everything, I am still very optimistic about the prospects for the U.S. economy.  
  • HOSTSEARCH: I mean the buck stops with the President, and the US President has been applying current policy with substantial vigor. Will it work? Will the President's policies get capital flowing again?
    FRANK STIFF: I feel strongly that the combination of the President's and Federal Reserve's actions (expanded money supply, fiscal stimulus, backstopping the banks, etc) will accelerate the pace of economic recovery from what might have been without such actions.  Indeed, the financial markets currently seem to be indicating that the recession is near, if not at its bottom.  Unfortunately, as employment lags recoveries, we can expect the high unemployment rates to persist for some time.
  • HOSTSEARCH: Well, it's been great talking to you, let's hope that in the rest of 2009 we start seeing the light at the end of the tunnel.
    FRANK STIFF: Absolutely!

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