Small Cap Stocks

Savvis (SVVS) announced yesterday that is acquiring Fusepoint. Fusepoint operates three data centers in Toronto, Vancouver and Montreal. Fusepoint’s three data centers have a total of more than 40,000 sellable square feet, with Toronto the largest at 28,000 sellable square feet.

According to the press release:

“Under the agreement, Savvis will acquire Fusepoint for $124.5 million in cash, subject to a working capital adjustment. For the first quarter of 2010, Fusepoint’s annualized revenue was $47.4 million. Adjusted EBITDA for the first quarter was $3.0 million, or $12.0 million on an annualized basis.”

The above implies a multiple of about 10X EBITDA (though I do not have any balance sheet information for Fusepoint).

It is interesting to do some quick back-of-the-envelope calculations on INAP with the above numbers, with the obvious caveat that the businesses are not entirely similar, and again a balance sheet is lacking for Fusepoint to make more accurate calculations. However, given INAP’s renewed focus on the data center business (an excellent strategy), and the availability of other comps, I think a Fusepoint is a decent comp for INAP.

Doing the numbers: INAP’s annualized revenue is about $240 million with annualized adjusted EBITDA of $40 million (16% margin vs. 25% margin for Fusepoint).

So even giving INAP a 8X EV/EBITDA, as opposed to 10X (my assumption for Fusepoint), leads to a $6.40 per share valuation for INAP. However, I expect INAP’s margins to improve going forward (up to 20%), so I do think INAP will ultimately fetch 10X EV/EBITDA or well over $400 million/$8 per share in an acquisition. I still believe INAP will be acquired in the next 12 to 18 months, one the data center expansion is completed and the company demonstrates traction with the new data centers.

Disclosure: Affiliates of Envoy Global Research, and its principals, own shares in INAP. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

There is no doubt that Internap’s earnings report last week was simply exceptional. But, of course, “The Market” is always looking to the future, which is why INAP’s projected results are far more important to investors than past reports.

So what’s in store for 2007? Last week, the company announced the following forecast for 2007:

“Revenue guidance of 30% for 2007, which includes the acquisition of VitalStream Holdings, Inc.; Full year adjusted EBITDA is expected to be in the range of $34 to $37 million; Full year expected adjusted gross margin to be approximately 50%; and Capital expenditures are expected in the range of $15 – $20 million. “

Interestingly, this guidance almost exactly matches the forecast we provided in this past post. However, if the past is any guide, Mr. Deblasio, Internap’s CEO, has low-balled Internap’s top and bottom-line prospects in the coming year, especially since the above forecast seems to imply zero growth in the VitalStream/CDN business in 2007, an outcome which seems to us to be highly improbable. Therefore, it seems highly likely that Internap executives will revise their guidance sharply upwards as the year progresses.

The question, though, is whether such revised guidance will help boost the company’s share price.

In all honesty, since we can’t predict the movement of stock prices, we’ll have to plead ignorance on this issue. However, we would remind investors that the valuation of Internap is best approached by reference to the two heavyweights in the company’s industry: AKAM and EQIX.

To the extent that these two companies retain their extraordinary high absolute valuations, it seems likely that Internap’s share price will provide market-beating returns in the coming year, especially if guidance is revised upwards, as we expect.

But, if the ever changing “Market” decides to shift capital away from these highly-valued, and much-hyped, equities, into more attractively-priced tech securities, it’s difficult to see how Internap’s stock price will perform well in this type of environment.

The bottom-line is that we believe that Internap, and many of the other stocks in the IP Services sector, are no longer undiscovered or undervalued on an absolute basis. Therefore, we think that one has to approach these stocks with caution, as the risk/reward is no longer as favorable as it once was.

Please Note: We first recommended Internap (IIP) at $4.00 per share, and still hold a position in the stock. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed
as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

The situation at Internap (INAP) is fairly simple: The company is undergoing a major transformation in 2007 due to the acquisition of VitalStream.

Putting aside all the various business justifications for the purchase as detailed in Internap’s S-4 filing, the primary reason for the acquisition, as we have stated in the past, is that Internap and VitalStream management are attempting to provide Wall Street with an alternative to Akamai.

And who can blame them? With Akamai trading at approximately 35X+ Enterprise Value (EV) to 2007 EBITDA and over 15X EV to 2007 Sales, a successful competitor could seemingly see a significant appreciation in its share price.

In the case of Internap, post the VitalStream purchase, the company is looking to have about 50 million shares outstanding, $240 million in 2007 revenue, $35 million in EBITDA, and about $100 million in net cash. Putting that all together and applying an Akamai-like valuation to the business (ex low-margin revenue streams), implies a potential upside target to Internap (INAP) of between $25 – $30 per share.

The question, of course, is whether Akamai’s, seemingly obscene, valuation is at all sustainable? Unfortunately, nobody has an answer to that question, which is why we caution that investors in Internap prepare themselves for continued volatility in Internap’s (INAP) stock price over the next year.

As for us, we’re holding onto our INAP shares, primarily because we’re optimistic on the IP Services/Managed Hosting sector over the coming years, and we see little reason for a sustained collapse in share prices. We also suspect that INAP’s numbers in 2007 could exceed the above estimates, given management’s propensity for conservative financial guidance. At the same time, the high valuations throughout the sector (i.e. AKAM, EQIX etc.), suggest that share gains in 2007 maybe more subdued than in past years.

Please Note: We first recommended Internap (IIP) at $4.00 per share, and still hold a position in the stock. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed
as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

It’s hard to believe that it’s been almost a year since we first recommended Internap (INAP) at a split-adjusted price of $4. Back then pessimism concerning Internap’s future was clearly in fashion, as the company struggled to prove the economic viability of its business model. Fast forward one year, though, and Internap has suddenly become a Wall Street darling.

Our short take on the Internap (INAP) acquisition of VitalStream:
This is a risky attempt on the part of Internap to gain a Akamai-type valuation on Wall Street.

However, these types of acquisitions usually only make financial
sense when the purchaser has a higher multiple than the target. The
exact opposite, though, is the case in the Internap/VitalStream
combination. So either Internap management thinks their stock is very
undervalued on a relative basis, which the coming quarters may or may
not show, or they’ve entered into a highly overvalued transaction.
Which one is it? Only time will tell.

So  overall, despite retaining our shares in Internap, given the
very favorable industry environment for managed Internet service, we
remain lukewarm on this acquisition, especially since our experience
has been that growth thru acquisition, especially when done with no
regard to absolute valuation measures, almost never lives up to its
hype.

Disclaimer:
We own shares in Internap. This site may include market analysis. All ideas, opinions, and/or
forecasts, expressed or implied herein, are for informational purposes
only and should not be construed as a recommendation to invest, trade,
and/or speculate in the markets. Any investments, trades, and/or
speculations made in light of the ideas, opinions, and/or forecasts,
expressed or implied herein, are committed at your own risk, financial
or otherwise.