It’s hard to believe that it’s almost 2 years, since I last recommended Internap (INAP) at around $3.75. Since then, like a good INAP shareholder, I’ve held onto my shares, trusting in the CEO and hoping for a buyout. The stock price, like many other small cap stocks, has fluctuated wildly since late 2009, reaching a peak of over $8 this year, and then falling over 40% during the summer 2011 crash.
Following the recent decline, I’ve again become optimistic about INAP and increasingly believe (yes I know this sounds like a broken record), that the company’s end game is approaching. First, there was an open market purchase, on 8/9/2011 by CEO Eric Cooney (I believe his first ever) for 53,000 shares at $4.90.
Company Not For Sale
Then late last week, Internap (INAP) released a curious PR entitled: “Internap not for sale, bets on data center growth: CEO”.
In the release, CEO Eric Cooney, told Reuters, “I am not shopping the company and we listen to any offers that come in and respond accordingly.” The article further explained that, “Internap is betting on growing demand for web-hosting in data centers…marking a shift away from its other business, IP services.” Mr. Cooney concluded by telling Reuters, “Increasingly we will look much more like Rackspace, Savvis or Terremark did before they got acquired.”
A company issuing a press release letting the market know it’s not for sale? Doesn’t this type of talk sound quite familiar?
Interestingly, since the PR, INAP’s stock price has climbed nearly 15%. The question, as always, is what’s next? Is there more upside?
Savvis Also Wasn’t for Sale
In trying to make sense of INAP’s “We are not for sale” press release, I dug up this press release from Savvis from back in January 2011: Savvis not in sale talks, eyes partnership: CEO
In the PR, Savvis’s CEO says , “We talk to a lot of different bankers, but we do not have one on retainer today. I guess if that sends a signal that we are not out trying to sell ourselves, that is as good a signal there is,” The Savvis executive said he was not surprised by the merger announcement between Verizon and Terremark, which already shared a partnership.
On the day of the above press release, Savvis’s stock closed at around $30 per share. Well, we know what happened next. In April 2011, Savvis sold itself to CenturyLink for $40 per share, or roughly $3.0 billion, including assumption of debt. This was a 30% premium to the press release price and represented an EV/EBITDA multiple (off of estimated 2011 EBITDA) of around 10.
INAP: Key is Margin Expansion
Given the above, what does the future hold for INAP?
To answer that question it pays to go thru our 3 step investment process.
1. What Went Wrong with INAP? Basically, INAP has never had the full benefit of “owning” it’s own resources. The company has primarily functioned as reseller.
2. What Has Changed? Since Cooney took over the company nearly 2 years ago he has been aggressively moving to expand its company-controlled datacenter space. Cooney has also started to get INAP working on new enterprise cloud services built on OpenStack.
3. What’s Next? The positive implications of Cooney’s changes are that INAP’s margins should continue to improve going forward and growth should pickup. Here’s the catch, though. SVVS’s EBITDA margins were around 27% when it was acquired. By comparison, INAP’s EBITDA margins as of last quarter were around 17%. So INAP has a long, long way to go to match SVVS’s financial profile. But, this gap, is where the upside is in the stock.
Currently, INAP is trading at around 6.6X EV/EBITDA. However, if EBITDA grows and margins improve, as I expect, clearly the current price will seem low. For example, If one assumes, for example, INAP grows to $45 million in EBITDA, and is acquired for 8X EV/EBITDA, then the stock price is roughly $7.00. But, it’s possible to envision higher EBITDA/Margin levels for INAP depending on the success of its initiatives. Higher margins would of course allow INAP to command a much higher takeover price.
The bottom line is that it should pay to stick around to see how the INAP story plays out, and possibly average down. INAP is clearly going to get acquired and probably already has received offers, so there shouldn’t be that much downside risk at current prices. But, the company can’t and shouldn’t sell just yet, until the margin profile is much stronger. You can bet Cooney wants to get 10X EV/EBITDA, but he won’t get it, until growth resumes and margins inch up significantly. The good news, is that I don’t think we’re that far away from either of those improvements. Last quarter, EBITDA margins rose 60 BPS year-over-year.