The True Value of My ISP

Reader discusses current ISP valuations.

[Response to Subscriber Values from May 10, 2001.]

[May 18, 2001]

Dear Editors:

This is long—sorry about that—and is meant only for those who really want a reality check on what an ISP is worth. I have been reading associated threads [on the ISP Lists] for some time regarding what an ISP is worth. I have seen speculation all over the place.

Besides the observation that something is worth what a ready and willing buyer will pay, here is my take on the subject:

Bruce Williams, a national radio talk show host, has been providing common sense on the subject of buying and selling business for over two decades. His formulas work except during the bubble when stock evaluations distort the market.

His point is that if the business makes a little money—basically paying the owner a living wage—it isn't worth much. On the other hand, if the business nets multiples of hundreds of thousands of dollars, it has a much higher worth based on that multiple, whatever it is. So the deal is to multiply that net times whatever based on the buyer's projections after due diligence.

Earthlink has onerous conditions associated with their purchase of customer base. I have seen reports that they offer so much for those who switch to them, plus another bit of money at the end of the year.

This works for them—and I suspect they have lots of experience on all the bad things that can happen to the purchaser of a dial-up ISP base. They are not some big bad ogre looking to screw people, they are simply a business looking for a return on what they invest—sorta like everyone else.

Self interest motivates all of us. Griping that someone else has placed their self interest ahead of your own is an exercise in dubious fantasy.

The basic conflict that happens with an ISP sale, or for that matter, any business where projections of future revenue are used, is that the seller doesn't want to be responsible for the dumb things that the buyer does to run off an acquired base and conversely, the buyer doesn't want to be responsible for the loss of revenue when customers go away over time; and they always do, for whatever reason.

The buyer also doesn't want to pay out money already collected, for example, on yearly accounts with an expiration 10 months down the road. Buyers are typically looking to introduce economies of scale to justify the capital outlay or to add economies of scale to their operation. Smart ones figure this into the equation.

Due diligence is what smart buyers do before they pay. This means that the better your books, the faster things happen, and the more likely you are to get maximum dollars for what you are selling. You better have a spreadsheet that shows it all, including monthly churn, average revenues, prepaid accounts, free accounts, and all the rest of the same things you would be looking for if you were to buy what you are selling. "Trust me" simply doesn't work.

Is or isn't equipment part of the sale, and how long are your Telco and backbone contracts—plus what are you paying for them? We recently reduced our backbone and Telco contracts by $3,800 per month—and that drove straight to the bottom line, an appealing factor for a potential buyer (no, we are not for sale).

How much web hosting you do (gravy), how much value added services you market, your growth pattern over time, but especially of late, and what is the ratio of credit card to cash payments, all influence what a smart buyer is likely to pay.

It just isn't X times gross revenue—or shouldn't be.

Currently, I do not know of anyone paying up front for a customer base except at heavily discounted prices. So much down, depending on the numbers, plus so much a month or quarter based on retention (higher) or it doesn't matter (lower) is the norm.

And there is some speculation that valuations are going to decrease over time, not increase. I am not sure about that. What I do know is that over time, I am building a better net worth through the process of improving my bottom line and developing a business plan that stresses value added services so we make more money. So I take my chances, and so does everyone else.

Williams says that a business which is basically styled to pay the owner a living wage is worth about what the owner makes in a year times one. He defines a living wage as less than $80K a year or so. Multiples of two, three, up to twelve or so, are based on the profits over that living wage that a business makes and the multiple number is a variable that increases based on due diligence and the higher multiples are paid for higher profits.

This is for mature businesses such as doughnut shops, body shops, grocery stores, etc. For businesses in industries which are growing, a higher multiple is used because of natural growth.

At some point in time, the ISP industry will start to become a mature industry, if it hasn't already. This means that valuations will go down somewhat for those who are not highly profitable. We have this to look forward to, like it or not.

One of the greatest pitchers of all times said, "Don't look back something may be gaining on you." That was Satchel Page. And it applies to the subject of ISP valuations as well. What was going on during the dot com bubble isn't going to happen again in the very near future. And the truth is, only a very few profited from that bubble by selling their businesses early enough to be able to dump the stock before the bubble broke.

Regards,

Larry Summers