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Interland/Web.com (INLD)

Posted on November 3, 2005

Note: Interland has changed it’s name to Web.com (WWWW)
Investment Summary: I believe that Interland (INLD) represents an excellent investment opportunity at current prices. I would buy the stock up to $3.25 and hold for as long as the business is being run prudently.

March 2006 Update: Please note that Interland (INLD) has changed its name to Web.com and now trades under the ticker symbol: WWWW.

Why buy Interland?
The stock has performed miserably over the last couple of years
(down from over $100 from the Internet boom) and operates in an
industry (i.e. Internet Hosting)that has not attracted investors for quite some
time. In fact, there have been several bankruptcies in the hosting industry during the telecom
and Internet meltdown ( remember Exodus
Communications etc.) . However, I believe that the negative sentiment
towards Interland will change over the coming year, primarily due to
specific changes at the company (i.e. a completely new management team,
see below, and the divestiture of unattractive businesses) and a
generably more favorable attitude to the company’s  Internet hosting business. I actually believe quite strongly that Internet infrastructure plays, like Interland and recently recommended RedBack(RBAK) will come back into favor with investors over the coming year, just as other pure play Internet companies (e.g. Google (GOOG) have. If you missed the first Internet boom, now is the time to jump into the next one. Venture Capitalists are throwing money again at Internet companies and these companies spend their money on infrastructure.

Business: Interland (INLD) operates in a fairly simple
business. It hosts websites for companies.  It makes money from the
monthly hosting fees. There are two types of hosting: shared and
dedicated. While dedicated hosting revenues are higher, they are
primarily targeted at larger business, which require dedicated
resources to manage their websites. Shared hosting, however, is
primarily geared towards smaller businesses, which don’t have much
traffic to their websites and can be serviced quite easily.Interland recently sold it’s dedicated hosting business (a good
move, since it’s not a great business), and is currently focused on
it’s shared, small-business hosting services.

Is shared hosting a good business? Well it has it’s positives
and negatives. Basically, in the shared hosting business you throw tons
of small websites with little to no traffic on a tiny server which
costs virtually nothing and charge all these businesses $30-$50 per
month. There are few cap-ex needs and the customer service issues can
be handled via the web for a low cost. That’s the positive. The
negative is that it is quite easy to start your own shared hosting
business, so the barriers to entry are low, pricing is very
competitive, and there are no real ways to add value. Overall, I
would say that it’s tough to scale up a shared hosting business, since
there are huge marketing expenses, but once you’ve got one, like INLD
has, it’s really a cash-cow, assuming you can manage churn successfully.

So the key question for INLD is: What can they grow from their base
of share-hosting customers? I’d say with some smart marketing, there
are tons of new and profitable services that INLD can offer to its over
100,000 small business customers. So I think the company has a good
chance of growing revenues and earnings very rapidly over the coming years.

Valuation Considerations (Downside Risk vs. Upside Potential):

Shares Outstanding: Including the recent granting of options
to the new CEO and other parties (see below), it appears that there are
about 18.5 million shares outstanding.

Recent Equity Transactions imply a $2.29 per share Valuation

From recent 8-K filing"In connection with Mr. Stibel’s appointment, the Company granted Mr. Stibelan option on July 28, 2005 to  purchase  1.7  million  shares of Company  commonstock  at an  exercise  price of  $2.29.  The  option  shares  vest  and  becomeexercisable at the rate of 47,222 shares per month,  beginning  August 28, 2005.On the three-year  anniversary of the grant date, all unvested  shares will vestand  become  exercisable. 

In addition,  Mr. Stibel  entered into a  Subscription  Agreement  with theCompany on July 28,  2005 under  which he has  purchased  250,000  shares of theCompany’s  common stock for a purchase price of $2.29 per share. 

In connection  with Mr.  Delgrosso’s  appointment,  the Company granted Mr.Delgrosso  an option on July 28,  2005 to  purchase  200,000  shares of  Companycommon stock at an exercise price of $2.29, on  substantially  the same terms asMr.  Stibel’s  grant,  except that Mr.  Delgrosso’s  option vests at the rate of5,555  shares per month  beginning  August 28, 2005,  with any shares  remainingunvested  vesting  on August  28,  2008,  and Mr.  Delgrosso’s  option  will notaccelerate  upon a termination  due to death,  Disability,  or within six monthsfollowing a Change of Control or Corporate Transaction."

Balance Sheet:

As of May 31, 2005, the company reported about $34 million in cash
and investments. Subsequently, the company sold assets and realized
about $9 million in cash (see below). So in total the company has about
$43 million in cash. The company reported about  $2.7 million in debt
and about $12 .6 million in accrued expenses. So give or take some
cash, I think the net liquidity position of the company is about $30
million.

Book value was about $35 million as of May 31, 2005. Adding in
another $9 million of cash, brings book value to about $44 million.

Overall, net liquidation value of between $30 and $45 million.
I’ll go with a safe $37 million valuation or about $2 per share. That
represents the downside risk here.

Notes to recent transaction to sell dedicated hosting business: "The $14 million in gross cash proceeds will be
reduced by $2.8 million that will be held in an escrow account for 12
months and by approximately $1.4 to $2.2 million in
transaction-related expenses."

Current Business:

The company recently sold a portion of it’s business, which represented 37% of sales.

From recent press release regarding sale of business: "The dedicated server assets accounted for approximately 37% of
Interland’s revenues for the nine-month period ending May 31, 2005."

Based on the most recent 10Q and looking at revenues from the last 10K,
one can estimate that continuing operations have sales of about $57
million. What’s the value of these sales? Well, it appears that the
company just sold it’s other business for less than 42% of yearly sales
($14 million for about $33 million in sales). Applying a 40% valuation
to $57 million, yields a value of $22.8 million or $1.23 per share.
However, I do think that a 40% valuation of the remaining business, is
much too low, since this business is actually more favorable than the
dedicated business.

Summary Valuation: Taking the liquidation value of $2 and adding
in the business value of $1.23 per share, yields a fair valuation of
about $3.25 per share.

So $3.25 would probably represent the minimum value of the business right now, assuming they do nothing and just maintain it, which is of course unlikely.

Management

Interland recently hired a new CEO, Jeffrey Stibel. This guy has a pretty good track record as an Internet entrepreneur, so I’m betting he’ll be able to leverage INLD’s assets to grow the business. Plus he’s pretty well incentivized to get the stock up. Below is his bio from INLD:

Jeffrey M. Stibel was appointed as President and Chief Executive Officer of Interland and a member of the Board of Directors in August 2005. From August 2000 to August 2005, Stibel held executive positions at United Online, Inc. (Nasdaq: UNTD), a technology company that owns and operates branded ISPs (NetZero, Juno and BlueLight Internet) and Web services (Classmates.com, MySite, PhotoSite and FreeServers). Stibel was most recently Senior Vice President overseeing the Web Services division, including Web hosting, email, online digital photos, search and domain registration. Prior to working for United Online, from September 1999 to August 2000, Stibel was Chairman and CEO of Simpli.com Inc., a search and marketing technology company currently owned by ValueClick, Inc. (Nasdaq: VCLK). Stibel previously worked at GTE (Verizon) on SuperPages, an online yellow pages and ecommerce business directory. In addition, he has worked in mergers and acquisitions at the law firm of Skadden, Arps, Slate, Meagher & Flom LLP and in marketing for The Greenfield Consulting Group. He currently serves on the board of directors for several private companies. Stibel received a master’s degree from Brown University and studied business and brain science at MIT’s Sloan School of Management and at Brown University, where he was a Brain and Behavior Fellow.

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