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Can the purchase of key US data centers boost C&W's global presence in IP services?

November 30, 2001

5 Min Read
Cable & Wireless Takes On Exodus

Cable & Wireless PLC (NYSE: CWP) this morning announced its intent to buy most assets of beleaguered Internet carrier Exodus Communications Inc. (OTC: EXDSQ) in a deal initially worth about US$850 million (see Cable & Wireless to Acquire Exodus).

C&W says it will lay out $580 million in cash for "substantially all" of Exodus's customer contracts in the U.S., Europe, and Japan. This amount also will cover 30 of Exodus's 44 data centers worldwide (26 in the U.S., two in London, and one each in Tokyo and Frankfurt); as well as all employees, brand names, and intellectual property associated with the facilities.

C&W also plans to front about $270 million cash for "certain assumed liabilities" accrued in the deal, such as payouts to employees who won't be taken onto the new payroll. And C&W intends to invest approximately another $250 million over the next three years to fully incorporate the Exodus assets into C&W and make them profitable by March 2005.

Interestingly, Exodus published slightly different figures for the deal than those touted by C&W, citing the initial sale as involving $575 million in cash and $180 million in other liabilities. Exodus didn't return phone calls today, but C&W says the difference is accounted for by C&W's more conservative estimate of what may have to be written off to complete the merger.

Terms of the agreement must be approved by U.S. bankruptcy court in Wilmington, Del., where Exodus filed for Chapter 11 protection late in September 2001 (see Exodus: What's Next?). Ultimately, analysts say, Exodus's debtors will be settling for a certain "amount on the dollar" value of the deal. Exodus is also open to higher bids. Closing is expected to happen early in January 2002.

In a conference call with analysts early this morning, C&W chief executive Graham Wallace conceded that the agreement will ultimately cost C&W about $1.3 billion -- which he seems happy to pay. By his lights, C&W plus Exodus will own 25 percent of the Web hosting market worldwide and will grow at a rate of about 20 percent annually.

"We've not just bought assets, we've bought... customers and market leadership position," he said. "That gets a different valuation than just raw assets."

But the news brought a slew of questions from investors: Has C&W paid too much for too little, too late? Has it chosen to hitch its wagon to a market that's already been dibbed by other players?

Analysts say there's no pat answer. "This is a positive move for Exodus... Whether it's positive for Cable and Wireless remains to be seen," says analyst Jay Slattery of Technology Business Research Inc.

Much depends on how creative C&W can be in making the most of Exodus's customer base. "Exodus had the best customer list in the Web hosting industry," he says. The buy also gives C&W access to the North American market, where it desperately needs inroads, and which its purchase of Digital Island (Nasdaq: ISLD) in summer 2001 didn't really deliver.

But Slattery notes that C&W is up against considerable competition from IBM Corp. (NYSE: IBM) and Electronic Data Systems Corp. (NYSE: EDS), which already have substantial chunks of worldwide Web hosting revenues from big business.

Others agree. "The jury's still out on the Web hosting market," says analyst Paul Sharma of J.P. Morgan & Co. But he says C&W is taking a gamble that may prove out in the long term if the carrier can stay smart.

After all, Sharma says, C&W is buying assets worth $2 billion for roughly half the price. "It won't be too hard to make a return on the investment." But he acknowledges that right now, market uncertainties effectively neutralize the half-price deal C&W is getting.

On the plus side, analysts point out C&W has plenty of cash to help it develop this opportunity. Indeed, Slattery says the company's been under some pressure from shareholders to start doing something meaningful with its multibillion-dollar cash reserves. In today's conference call, Wallace addressed this as well, indicating that the latest transaction will help to roughly halve the $4 billion cash balance on hand.

For its part, Exodus says the deal is part of its ongoing reorganization process. While not referring specifically to the deal, Exodus's chairman William Krause told customers in a conference call yesterday that it was part of his plan to try and keep services going for Exodus's loyal customers, either under new ownership or as part of a re-funded independent company -- or both.

Many unanswered questions remain. For one thing, it's not clear what will happen to the assets C&W doesn't buy -- those remaining 14 or so data centers, for example. Analysts say Exodus is likely to try and sell what C&W doesn't take to other hosting companies. Alternatively, it may close them and take a loss.

Other questions pertain to how the deal will affect third parties, such as Global Crossing Ltd. (NYSE: GX), which has contracts in place with Exodus for hosting facilities.

C&W acknowledges that, as Exodus data centers are blended into the C&W network, it's likely some facilities leased from other carriers will be terminated. Indeed, this is one of the key incentives C&W is giving for buying Exodus in the first place. But only time will reveal specifics.

Investors apparently agree with analysts' cautiousness on the deal: By midday, shares of C&W were trading at $14.27, down $0.82 (5.43%). Exodus shares rose 2.94% on the OTC bulletin board of penny stocks to trade at $0.10.

— Mary Jander, Senior Editor, Light Reading

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