Fixed Wireless Business

Covad's Acquisition of NextWeb Makes Sense

It's the biggest ISP deal in recent memory. WISPs are interested, especially those hoping to sell out at the same valuation. So here's the deal.

by Alex Goldman ISP-Planet Managing Editor [October 11, 2005]

Fremont, Calif.-based NextWeb is a nifty fixed wireless broadband company with some unique advantages. The company's deal with healthcare giant Kaiser Permanente gives it access to key rooftop real estate both in its California and Nevada coverage areas and beyond.

NextWeb has a reputation for marketing well, and has been acquiring other WISPs at a rapid clip, while retaining its regional focus.

To prospective buyers, all of this would make NextWeb stand out. To Covad, the fact that NextWeb's corporate headquarters is close to Covad's is a bonus, made better by the fact that NextWeb's lease on its headquarters expires in April of 2006.

San Jose, Calif.-based Covad expects its acquisition of NextWeb to close before the end of the year. "We hope it will close within six weeks," says Pat Bennett, executive vice president of Covad Communications.

Financials
Covad announced [.pdf] that it is acquiring NextWeb for $24.7 million: $4 million in cash, $19 million in stock, and the assumption of $1.7 million of debt.

We were surprised that NextWeb (and its key investor, Kaiser Permanente) was willing to take so much stock instead of cash. Most ISP deals today are cash plus the assumption of debt (and ISP broker Tom Millitzer argues that taking on debt lowers the cash outlay and is useful for profitable ISP businesses that are nevertheless unable to obtain loans for acquisitions).

"We are encouraged by this," admits Bennett. "NextWeb investors believe in the Covad story and see value in taking equity as opposed to cash in the deal."

ISPs have traditionally been valued at a per subscriber rate, and more recently, in the post-boom era, at a ratio of annual earnings rarely greater than 1.5.

NextWeb's revenue last year was $8 million, with an EBITDA or $348,000. While the Covad press release touts a gross margin of 70 percent, the EBITDA ratio is a more pedestrian 4.35 percent. Of course, if you can eliminate many of the costs, you may be able to achieve better results than NextWeb.

Bennett argues that the consolidation of headquarters will achieve some efficiencies, and that although NextWeb's marketing group is excellent, combining it with Covad's should achieve real synergies. In addition, Covad's backbone should lower NextWeb's operating expenses.

Without such synergies, Covad might, in fact, have paid less. "We thought the company's stand alone value was $18 million or $19 million. But we thought it was worth more because of its strategic value, and because although its 2004 revenue was $8 million, its 2005 estimated revenue is $10 million with an EBITDA of $1.7 million," says Bennett.

Taking a line directly out of the press release, Bennett adds, "Covad still remains on track to become EBITDA profitable by mid-2006 and cash-flow positive by the end of 2006."

Valued on a per-subscriber basis, NextWeb's 3,000 customers seem expensive at $24.7 million, about $8,000 per customer. But all of NextWeb's customers are businesses, and ARPU, at $350, is above the industry average. Nevertheless, Covad must believe that it can add customers in NextWeb's footprint.

In fact, the press release confirms that a key benefit NextWeb brings to Covad is that it "increases Covad's market footprint in two of its most important markets: the San Francisco Bay Area and Los Angeles."

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