Callplus recently sold for 5.6 times EBITDA, Orcon was sold for $38m in 2013 to Warren Hurst and some private investors at a point where it was earning approximately $80m in revenue, but (I am told) was running at a loss. Callplus then picked Orcon up for approximately $30m in 2014. FX was bought for $107m worth of shares and cash by Vocus at a time where it was making $13m in EBITDA, but running at a loss.
The point here is to highlight that there is no clear multiple used when determining the value of an ISP. It all comes down to how much the buyer wants the transaction to happen and the drivers the vendor has for selling.
I have never sold a business, but I have been heavily involved in the decision to purchase one, and plan to do so again, so this post is about outlining how I determine the value of an ISP or telecommunications provider.
Business owners often have an unrealistic price in mind when they look to sell their business. This can be because they are thinking of how much money they need for their next venture, because they place unwarranted value in the effort they have put in to build the company, or because they have heard of a larger ISP being sold for 1 x revenue and believe that valuation method should apply to them.
I have been in a number of situations now where the owner of another small to medium ISP or telecommunications provider has provided me with their preferred sale price and almost immediately ruled out a deal being struck. Of course these meetings always contain an element of negotiation, but in a number of instances, the gap between their expectation and a fair market valuation has been too wide to bridge.
It is easy to just target a multiple of EBITDA, perhaps three or four, but that is overly simplistic.
These are the points I consider in order to derive a valuation for a small to medium size ISP or Telco:
- Contract terms. We need to know that revenue is sticky. Ideally 60% of clients will have 12 months or more left in term.
- Distribution of income across clients. Too many eggs in one basket represents a high level of risk. In one scenario we were involved in, a business had 25% of their income with a single client, and that client was out of term. We passed.
- Distribution of income across revenue streams. Data has dropped in value, margin on tail circuits is going, and voice is a game of scale. Just as in retail, a key performance indicator is the number of items per sale. Ideally a new business acquisition will add scale to our existing market segments, and introduce a new one to us.
- Historical profitability. Given the decrease in margin in internet services over the past 24 months, I essentially decrease the previous years’ bottom line result by 25% or more to get a realistic view of their likely result in the coming 12 month period. In this part of the process their pricing needs to be heavily scrutinised, if it is out of line with market norms, then they will likely experience heavy churn as clients contracts expire.
- Historical growth trends. Growth in client numbers and services used per client are more important than historical margin (for the reason given above) and will be what determines future profitability. Then we need to understand how new business has been gained, and we need to be sure that formula can be maintained post sale.
- Synergies that can be gained. Do we have providers in common allowing us to reduce connection costs and/or gain better economies? Do we have POP’s in the same town, giving us the ability to close one or more down? Will any existing offices need to be retained? Will the existing owner be required to stay on board in a management role?
- The reason for selling. Are they struggling? Do they know of impending challenges? Is core infrastructure end of life and they can’t afford the upgrade?
- Historical spikes in revenue or troughs in expenses. These need some serious investigation.
- Dependence on individual staff members. Small companies often have single points of failure with individuals acting as single silos of knowledge. If you buy the company, what can you do to keep those essential staff members and have them train others?
- What else is going on in the market? Are new competitors emerging? Are the existing service platforms you are going to acquire through the sale in need of upgrading or development to keep pace?
- What is the risk to your business of not buying the company you are looking at? If they provide services to you currently, what is the risk of a competitor buying them?
This isn’t an exact science, but ultimately it comes down to the cost of borrowing versus the increase in profitability from the acquisition, and for each one of the above considerations that is not ticked off in the due diligence process, the likelihood of covering the cost of finance becomes less likely.
DTS bought a company in December last year, we paid about 4 x EBITDA. We did this for a number of reasons, including:
- They were an existing wholesale IP voice provider who was likely to sell to a competitor if we didn’t act.
- Their network was aging and needed upgrading that they couldn’t afford. We had the choice of building our own service platform and migrating our clients to it, or we could buy them and improve their existing network. The latter proved to be the most appealing option.
- The majority of their retail clients had internet via other ISP’s which presented us with a great opportunity to gain hundreds of new connections (which I am happy to say we have been doing very effectively).
Let me know if I have left out any obvious considerations, might help to keep me on track when we next go through the process.