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Verizon borgs Terremark for $1.4bn

Cloud absorption

Telecom giant Verizon will shell out $1.4bn in cash to buy managed services and cloud computing partner Terremark Worldwide, bootstrapping itself into the upper echelons of the emerging cloud providers.

Verizon Business, the IP networking and hosting arm of the telecom company, already resells white-label cloud computing products that run in Terremark data centers, and it's cognizant of the fact that it can't alienate Terremark's existing government and commercial customers by doing away with the hosting company's carrier-neutral philosophy. And so Verizon plans to run Terremark as a wholly own but independently operated subsidiary, with Manny Medina, chairman and chief executive officer, still at the helm and all of Terremark's employees remaining with the company.

Terremark is itself a publicly traded company, and had a market capitalization of $930m yesterday before the deal was announced. Net of cash, at $19 per share, Verizon is paying a 35 per cent premium to get its mitts on Terremark. At $1.4bn, this is the largest deal that Verizon has done since it acquired MCI Communications for $8.4bn, giving Verizon a global IP network and laying the groundwork for its hosting aspirations.

In a conference call with Wall Street analysts, Lowell McAdam, president and chief operating officer at Verizon, said that Verizon had looked at the opportunity for cloudy infrastructure sales and realized it could not capture as much of the opportunity as it saw with organic growth. Once Verizon came to the conclusion it needed to buy a provider with managed services and cloud computing capabilities, it focused in on e Terremark because the two companies complement each other better than other possible combinations might. (Rackspace Hosting comes to mind, and by the way, but would cost $5.5bn to acquire at the same premium.)

Verizon Business, the IP network and server hosting unit of the telecom company, has over 180,000 customers in 75 countries, and McAdam bragged that it was the first to deliver 100 GB/sec (that's bytes, not bits) long-haul service over its IP network. Verizon has a total of 200 data centers scattered around the globe, with five being dubbed "smart," 16 being "premium," 29 being "advanced" and 150 being "standard." The IP network is available in 2,700 cities in 159 countries and Verizon Business has over 3,000 techies who run the network and systems. Verizon has strengths in Europe and in Asia as well as among midrange and large enterprise customers for its network and hosting services.

Terremark was founded in 1980 by Medina in Miami, Florida. The company has grown more or less steadily in terms of sales, data center footprint, and employee count, but it has not been profitable on an annual basis thanks. In fiscal 2008 (ended in March), Terremark had $187.4m in sales, but lost $42.2m. The company had 698 employees, 983 customers, and 385,030 square feet of data center capacity with 23 per cent utilization.

Fast forward to fiscal 2010, Terremark boosted its data center capacity to 504,000 square feet, its customer count to 1,350, and its utilization to 29 per cent, pushing revenues up to $292.3m. But the company also lost $31.7m. In the prior five fiscal years, Terremark has booked 136.6m in losses on $893.7m in aggregate revenues. As its fiscal second quarter came to an end in September, the losses continued, with sales up 21.6 per cent to $84.9m but with Terremark putting $7.7m more in red ink on the books. The company was moving in the direction of profitability, with sales projected to be up $351.5m in fiscal 2011 ended this March and sales of its Enterprise Cloud utility, based on VMware's vSphere stack, were at an annualized run rate of $30m. Data center utilization was on the rise, too, with 37 percent of capacity being used on the first fiscal quarter.

If Verizon was going to buy Terremark, now is the time to strike. If it waited and the company started to soar, it would be more expensive and might fall into the hands of another player, such as AT&T, IBM, Hewlett-Packard, or maybe even EMC.

Terremark's main data centers are in Miami and in Culpepper, Virginia, the latter being from where it services its Federal government customers. About a fifth of Terremark's revenues come from Uncle Sam, and McAdam admitted that Verizon Business was not particularly strong in Federal sales. About half of Terremark's revenues come from managed services (which includes the Enterprise Cloud compute utility as well as traditional hosting), 44 percent from co-location services, and the remaining slice from network connectivity services called Exchange Point. The Enterprise Cloud business is growing fast, up by a factor of 15 in the past six quarters.

Terremark runs data centers in Sao Paulo, Brazil; Bogota, Colombia; Santo Domingo, Dominican Republic,; Brussels, Belgium, Madrid, Spain; Amsterdam, the Netherlands; and Instanbul, Turkey. In the United States, Terremark has two other data centers, on in Dallas, Texas, and one in Santa Clara, California. The company has a large and growing business in Latin America, where Verizon is not strong.

Verizon and Terremark think that they can realize about $500m in synergies - cost cuts and revenue cross-selling opportunities - to make the Terremark deal pay. Verizon says that the deal will be neutral to earnings per share for the telecom giant in its 2011 and will be accretive to earnings in 2012. A bunch of Verizon data centers will be immediately transferred to Terremark to operate as soon as the deal closes, within 90 days or so, because McAdams said that building and running data centers was not Verizon's "core competency." Terremark had $85m in data center expansion plans in its capital budget, and as soon as the deal closes, Verizon's own data centers and the current and future ones from Terremark will all be rationalized.

McAdam said that three key Terremark shareholders, who own a combined 26.7 per cent of the company's shares, have backed the deal, as have both companies' boards of director.

The key thing for now according to McAdam is that Terremark's relationship with VMware for the Enterprise Cloud remains strong and that the carrier neutrality for the co-location services remains unchanged. The Miami data center has 170 different carriers plugged into it, and the last thing that Terremark can afford is for customers to think that Verizon IP is their only option. ®

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