By Peter V.K. Funk, Jr. and Larry Hughes
Mission Critical magazine
June 1, 2011

For a data center owner with a growing need of additional data center or infrastructure capacity, acquiring a company or its data center assets may be a good option. It can be faster and less expensive than finding sites and constructing new facilities, expanding existing facilities, or developing new technologies.

Acquisitions since 2009 in the data center sector have been largely driven by a need for storage, expanded data processing, and searching capabilities. HP acquired 3Par, which develops large-scale storage arrays permitting enhanced storage capacity, for $2.35 billion to buttress HP’s cloud computing and infrastructure businesses. EMC acquired Greenplum for an undisclosed cash amount and Data Domain for $2.4 billion. Greenplum had provided a data warehouse for eBay and significantly enhanced HP’s data capabilities. EMC’s acquisition of Data Domain added capabilities including data storage and consolidation together with recovery of data center operations.

Similarly, IBM’s acquisition of Netezza for $1.9 billion added to its capability to handle large-scale data. Oracle’s acquisition of Sun in a deal valued at $7 billion, brought Oracle server, processor, and storage capabilities. Each of these acquisitions demonstrated that acquiring rather than developing large-scale data capabilities can be an important expansion tool.

It is a given that any acquisition, large or small, requires due diligence and raises numerous issues that need resolution. As a potential acquirer, your first instinct, and a logical starting point, is to focus on “targets” that possess the data servers, and the processing, storage, and data mining technologies that are necessary or desirable in assisting you in meeting expansion goals. Assuming you are successful in locating a desirable target, you will find many other factors to consider and hurdles to overcome. For instance, while acquiring the target may establish control over its assets, the purchase also typically subjects the acquiring company to known and unknown risks and liabilities.

The tax and accounting aspects of any such transaction may have a greater impact on the transaction’s cost or value, as well as on timing, than the unwary might realize. Does the target have contracts with potential “time bomb” provisions (e.g., such contracts may prohibit the transfer or assignment of sought assets in a contemplated acquisition transaction)? Is the target a closely held family company with hard-to-untangle family considerations? Are the employees represented by more than one union? The target may be subject to litigation that significantly affects the value of the target’s assets or goodwill. The “list” of considerations to be addressed in almost any acquisition is well beyond the scope of this article, but suffice it to say that finding a target that is a perfect fit and integrating it into the acquiring company can oftentimes be quite challenging, a lesson that is repeatedly learned. Knowledgeable and extensive due diligence is a key foundation of a successful acquisition.

While there are numerous approaches to structuring mergers and acquisitions, the most basic methods are asset or stock acquisitions (including, in a stock acquisition, the merger of companies by the acquirer directly or indirectly acquiring the target company’s stock). In the typical asset acquisition, the acquirer is able (subject to negotiation of course) to specify the particular assets it desires and the specific liabilities it is willing to assume. Issues like the requirement to obtain the consent to assignment of contracts are more likely to arise in asset acquisitions than in stock acquisitions, while there’s less likelihood that securities law compliance would be a factor in an asset acquisition relative to a stock acquisition.

In stock acquisitions, the assets and liabilities of the target remain in the target company and the stock acquirer is unable to pick and choose assets. On the plus side, however, obtaining consents to assign contracts may present less of an issue since contracts remain contracts of the target. On the minus side, unknown and contingent liabilities that present a significant risk to the acquirer may remain in the target Another minus factor of stock acquisitions is that securities law compliance may be a significant, costly, and time consuming burden for the acquirer.

The participants in M&A transactions typically hope to achieve economies of scale and reduced costs due to the elimination of redundancies between organizations. Some of the other goals or factors to be considered include achieving economies of scope, increased revenue or market share, various other potential synergies between organizations, tax and accounting benefits, and cost-selling opportunities.

Financing is the lifeblood of many M&A transactions. There are several methods of paying for acquisitions. Payment to the private owners or stockholders can take the form of cash, purchaser stock, or a combination of these. The source of cash can be cash on hand, cash derived from the issuance of stock or debt, funds commercially borrowed, or some combination of these.

From the seller’s viewpoint, understanding the value of the offer or bid is paramount. An all-cash payment, like EMC’s acquisition of Greenplum, has the benefit of being readily understandable. Determining the value of payment to be made by the acquirer’s stock is significantly more challenging since it requires an understanding of the acquirer and its market sector. A crystal ball would also be useful in predicting the buyer’s future and the likely effect of the transaction upon the price of its stock--although the latter is more readily forecast. On the other side of the transaction, accurate valuation of the seller is key for cash or stock-based acquisitions since issuance of the acquiring party’s stock to shareholders (or private owners of the acquired company) is proportional to its valuation.

Cloud computing continues to be a major factor stimulating M&A activity. As discussed in my previous column, cloud computing is substantially increasing demand for additional data center capacity despite concerns with security and legal issues. The need for company growth can be driven by factors including increasing numbers of customers, expansion of existing customer needs, or the growth of internal company requirements.

Cloud platform and infrastructure providers are likely to see economies of scale and infrastructure dominance as powerful competitive tools. For these reasons, we expect to see large-scale data providers seeking to expand through acquisition as a basis for gaining position in the marketplace and as protection against larger competitors. The bellwether $1.4 billion acquisition this year by Verizon Communications of Terremark Worldwide, a cloud-computing company, is likely to stimulate other carriers, such as AT&T, to make similar acquisitions. Acquiring Terremark provides Verizon with access to data storage servers on several continents. On the heels of the Verizon/Terremark transaction, another telecom company, Time Warner Cable announced its acquisition of NaviSite, a cloud and data center hosting company. It appears likely to us that we will also see defensive acquisitions as “pre-emptive strikes” before competitors can move or the outbidding of competition, as EMC’s purchasing Data Domain for $2.4 billion besting NetApp’s initial bid of $1.5 billion.

There has also been M&A activity in the colocation center (or carrier hotel) sector. Colocation is a type of data center where multiple customers utilize network, servers, and storage gear connecting them to telecommunications and network service providers with the intent of reducing cost and complexity. For example, during 2010, Equinix purchased Switch & Data for $689 million. Switch & Data provided data center space at a cost that presumably permitted Equinix to provide data center space at favorable pricing.

Another example is Digital Realty Trust, a very large wholesale data-center provider, which acquired a renovated data center portfolio located in Massachusetts and Connecticut for $375 million, thereby gaining access to new customers. It appears to us that other smaller players in major markets are likely to become targets for acquisition by the larger entities in the data center colocation market. A countervailing factor that may lessen future acquisition activity is that we would expect desirable data center facilities, such as larger properties with multiple tenants, to becoming more expensive as the economy improves.