Megabuyte

Telecity - it's all about capacity

Maiden full year results this morning from hosting provider Telecity show revenues to December up 42% to £97.9m and adjusted EBITDA of £23.4m, up from £11.0m in 2006. At the bottom line however, the company was break even. The statement notes that demand remains strong in the data centre market and pricing continues to be robust. Occupancy at the end of December was 81.3%, up from 75.9% at the end of 2006. Construction of two new centres - one in London and one in Amsterdam commenced during 2007 and will be commissioned in H1 2008.

Our View

This was an excellent set of results from Telecity although the City was disappointed that there were no upgrades and the shares are down 13%  to 210p as we write. Moreover, the investment community seems to be increasingly concerned about the medium term pricing outlook for hosting as significant new capacity becomes available. This change in sentiment has been reflected in the company's share price. Having roared away after the IPO, the shares have come back sharply in recent weeks and, after today's fall, are the worst performer in the Megabuyte Leaders Index so far this year.

Looking at an ISR Scorecard for Telecity,  we have a generally positive view. The hosting market is large and currently experiencing strong growth although the sustainability of that growth is open to question. Whilst there is certainly strong underlying demand for hosting services driven by developing internet use, hosting capacity is coming on stream rapidly which may impact pricing on a 2-3 year view. Telecity enjoys a market leading position in the key European centres and its track record has been strong since the post dotcom wipeout. Looking at service differentiation, however, whilst the leading colocation providers do offer a premium service, they are ultimately providing a commodity which is subject to the vagaries of the cycle. Where Telecity really scores, in our view, it on its financial dynamics. Strong revenue growth, attractive underlying margins and cash flow combined with high levels of visibility. Add to this Telecity's current balance sheet position and one has a highly attractive business model. We will expand more on these scores in the first issue of Megabuyte Journal out in early April.

So where next? 2008 is likely to be another strong year for the company. The new centres in London and Amsterdam will be open in the next few weeks and the market is looking for over 20% revenue growth and further margin expansion. However, the shares trade on an EV/EBITDA of around 13x which is ahead of the US peer group, whose valuation has slipped recently. Another potential downer on the shares is that, as the company's profitability improves, the shares will soon be able to be valued on a PE basis. We have seen many times before that, as companies have grown into their valuations, this can lead to a period of share price stagnation. Overall then, there is nothing in the immediate future to worry investors about Telecity's performance but much will depend on how the capacity coming on stream over the next couple of years effects pricing. Ahead of greater certainty of in this matter, we see few drivers for share price outperformance.

Megabuyte Monthly Journal - March 2008

Megabuyte Index Series

February was the month where the wider sector clawed back some of the loses incurred in January. The Megabuyte All Share was up 3.4% in February at 955.6. However, the Megabuyte Leaders Index of the ten largest stocks in the sector by market cap, slipped further in February, by 3.3% to 886.9. Given the relatively small number of constituents, the MB Leaders can be swung by the performance of a small number of stocks and so it was in February - Logica and Misys both dropped 14% in February and Sage was 10% lower. Of the ten constituents, only Datatec, which was a very poor performer in January, managed a robust recovery in February with a 13% jump to 210p. The Megabuyte 50 Index, which we would argue gives the best representation of sector performance, was up 1.2% on the month to 896.7. The Megabuyte Fledgling Index retains its place as the best performing index in the series  - it added 4% in February to close just 2% off its 2008 starting level. Outside of the top ten, Fidessa was the stand out performer of the month registering a 30% gain following excellent results. Dicom (now called Kofax) and SDL also impressed with results and the shares of both were up over 20%. Doing less well in the MB 50 were Medicsight (down 14%) and Bond International (down 21%). You can download our monthly summary here .

Trading round-up

Trading news was generally positive again during February although outlook statements were laced with the now familiar comments on the macro economic climate. However, few companies have seen any real impact as yet from the afore mentioned slowdown although some have started to pare back their investment plans as a prudent measure. Regular readers will know that we are bearish about the sector on a 12-18 month view and the fact that there has been little in the way of negative trading statements so far, does not alter that view.

In theory, Logica's results should have given a good sign of the general direction of IT spend. However, there is so much going on in that company at the moment, it is hard to make any direct connections between its trading and the wider IT market. For example, the UK business outside of the Public Sector market performed appallingly in 2007, but this does not reflect on market conditions, but more on Logica's execution. Looking more broadly at the larger stocks in the sector, the news was universally positive. Sage, Datatec and Detica all issued reassuring trading updates whilst Micro Focus said that it was slightly ahead of expectations and, as already noted, results from Fidessa (see our piece here) and SDL impressed the market. At the smaller end of the market, there were some wobbles, however. Macro 4 issued a lacklustre set of results and IBS OpenSystems and Maxima announced results in line with recent profit warnings.

Valuations

Valuations for the larger stocks compressed further in February but the small stocks have held up well. The average forward PE for the Megabuyte Leaders constituents fell from 17.2x at the end of January to 16.2x at the end of February. Given the relative outperformance of the Megabuyte 50 and Megabuyte Fledgling Indices, it is not surprising that the valuation gap between large and small actually closed a bit in February. The average forward PE for the MB 50 slipped slightly to 14.2x from 14.6x whilst for the MB Fledgling, it was broadly flat at 12.6x. The PE gap between MB Leaders and MB Fledgling therefore closed by 1 PE point to 3.5x during February. You can download our valuation summary here .

M&A

The emphasis in M&A continues to be on public companies being acquired rather than doing the acquiring. Bids for CODA, NSB Retail Systems and Vega all successfully completed during February and KKR's bid for Northgate Information Solutions is getting close to the finishing line. To add to the list of possible targets, Clinphone and Netstore both revealed that they were in bid talks during February. Public company acquisitions remain subdued with the acquisition Performa by Statpro and of Plantech by Idox, the only two notable deals in February.

Many have said, and we agree, that 2008 will be a good year for M&A. So it is at the end of every cycle. However, we do not believe that this M&A will be supported by the capital markets - indeed, the ability of technology companies to raise money through IPO of secondary placing is severely limited currently and we do not see that changing any time soon. There is plenty of cash on corporate balance sheets to sustain the M&A boom for a while but, as trading conditions get tougher through 2008, we believe that companies with cash will want to conserve cash rather than use it for acquisition. The natural conclusion to this will be a further depression in valuations and only one buyer left standing in 2009 namely Private Equity.

Looking ahead

The results season is in full swing and there will be a plethora of companies reporting over the next few weeks. We would highlight three to watch out for.

Finals from Axon Group tomorrow should give a good perspective on the UK IT services scene. Given the difficulties in the US economy, many observers are focusing on the company's US performance. Whilst the US may have been the engine of the company's growth over the last few years, it is the UK business that still delivers most of the profit. Also, Axon is still a minnow in the US and hence not a good indicator of overall demand. Operating margins in the EMEA business (which is 80% UK) topped 20% in H1 which we see as a clear sign that we are at or near the top of the cycle. The City being the City, estimates for Axon will be predicated on this margin continuing in perpetuity - we'll see. As an aside, it's also the first outing for CEO Steve Cardell without the company's founder Mark Hunter at his side. Having said that, we attended the September analyst briefing and Cardell did 90% of the presentation anyway, so it's perhaps not quite the wrench that it may seem to some.

Hosting provider Telecity will announce maiden full year results on 10th March following its successful IPO late last year. Although we haven't run a model on Telecity yet, the consensus view seems to be that there is plenty of upside potential in the estimates going forward. Certainly, the valuation, even after the shares have come of recent highs, suggests that there is plenty in the tank. We will also be looking for signs of weakness in data centre spending from the financial services sector which has been a big driver of growth in recent years. For us through, the more interesting longer term theme is Telecity's positioning as a beneficiary of the trend to on demand computing. As we said in our piece at the time of the IPO - picks and shovels in the gold rush - there is no doubt that the trend to on demand computing is driving an increased requirement for hosting. However, it is an open question as to how much of this capacity will be fulfilled by third party providers and how much by the application vendors themselves. We have all read about Microsoft, Google and others building server farms the size of football stadiums. Any clue to the latest trends in this regard will be very interesting and readers can see our previous piece on the subject here.

Computer reseller and IT services player Computacenter announces its full year results on 11th March and is generally good bellwether for IT spending in the UK. Certainly, the company's January trading statement was upbeat enough (you can read our thoughts on it here) but there are worries that strong current trading is being driven by soon to be cut data centre spending.

Megabuyte morning round-up 08.02.08

Another relatively quiet but not very positive day in the markets yesterday. The market was unimpressed with the quarter point rate cut and Cisco's downbeat statement overnight in the US weighed on tech stocks. The FTSE 100 closed down 2.6% to 5,724 and the Megabuyte Leaders Index dropped 2.2% on the day to 903.6. Dimension Data was the worst performer registering a 6% decline to 51p and Telecity was a poor performer once again (see below). The US was in perkier mood yesterday, however, and the NASDAQ closed up 0.6% to  2,293.

Telecity slips below IPO price

It may not be a particularly surprising headline, but Telecity shares slipped back through their 220p IPO price yesterday to close at 215p. Market observers will know that the shares soared following the company's successful IPO in late October and reached over 340p shortly after. At a conference recently, we were asked if we thought the jump in the price following  the IPO meant that the Telecity float had been underpriced. We said 'no' then and this is exactly why. It would probably have been possible for Telecity to achieve a higher valuation at IPO but, if it had, it may well be trading at a significant discount by now and observers would have written it off as a failed IPO. As it is, no one can blame Telecity for recent market conditions and short term investors have had plenty of opportunity to realise a significant profit on the IPO so, history will now record that IPO was a great success. Investors will therefore remember the IPO fondly and, importantly, that sentiment glow will stay with the stock for a long time to come. Telecity will report its maiden results on March 10th.

Megabuyte morning news 13.12.07

Yesterday's movers

Unsurprisingly, the biggest mover yesterday was Northgate Information Systems following a bid approach. The shares closed up over 20% to 72p, although this is only slightly higher than the level prior to the interim results on Monday. Anite was also lifted by the news - its shares added 11% to 46.5p as hopes that the long awaited Public Sector IT consolidation was on the way although the other stocks in the sector (Civica, IDOX and IBS Opensystems were unmoved). Another milestone for Axon that it would rather not have reached - the shares slipped back through500p yesterday and are not not much more than half their 12 month high. At the smaller end of the market, Computerland jumped 17% to 211.5p on no news and Xploite added another 7%to 63.5p following its announcement late on Tuesday that it was in bid talks.

Misys - trading update

There is a trio of trading updates this morning, two of which give some hope that fall out from the credit crunch has not yet impacted trading. Misys has said the trading for the first half to the end of November is ahead of internal targets. Revenue from both the Banking and Healthcare divisions is expected to show mid single digit growth over H1 2007. However, this revenue growth is driven more by IT services work rather than licence fees where Misys reports that sales of initial licence fees in the Treasury and Capital Markets have been disappointing although it put this down to sales execution rather than the economic climate. Also giving a positive view of the banking sector is staffing and IT services group FDM which has said that results for the year to December will be significantly ahead of expectations and that trading in the banking sector remains strong.

Telecity Group - trading update

Recently floated Telecity Group has also issued a trading update this morning saying that trading is in line with expectations and that it is pulling forward some of its capital expenditure plans to accelerate second phase development of some of its newer data centres in London and Amsterdam.

UK Technews 6.11.07

Yesterday's trading in Telecity shares put paid to any thoughts of consistent profit taking as they added another 5.5% to take them to 338p against the 220p IPO price. By our calculations, this puts the market cap at just under £700m - this for a company that delivered £46m of revenue and £10m of EBITDA in H1. We did a few calculations on Equinix, the NASDAQ listed company that acquired IX Europe this year and we reckon it is trading on around 14x EV/EBITDA to December 2008 ($250m EBITDA, market cap $4bn and net cash $400m). Going back to our previous assumptions that Telecity would achieve around £30m in EBITDA next year, it is trading on over 20x EV/EBITDA. Even if our estimate is on the conservative side, that's a pretty punchy valuation. Web 2.0 bubble? What web 2.0 bubble?

Video search engine Blinkx had another interesting move yesterday. The shares were up in the morning, but by the and of the day had lost 2p to end at a new low of 27.5p. We feel that this kind of move looks quite worrying as it suggests that any upward move in the shares is simply met by selling pressure. As long as this pattern persists,  Blinkx shares may fail to make significant progress. Elsewhere in the sector, Dicom shares were broadly steady following the appointment of a new CEO as investors wait to see Q1 results tomorrow. Further down the market cap scale, IT consulting firm Charteris and information management software company Infonic were winners yesterday with 9% and 8% gains respectively. Charteris continues to have momentum following encouraging results last week and Infonic announced an £8m contract with the MoD as part of the Atlas consortium on the DII project.

The morning, Micro Focus has raised revenue guidance for 2008 whilst reiterating that H1 trading is in line - see separate post. Micro Focus shares have  opened up sharply at 316p up 7.5% which is a new all time high. Shares in enterprise software vendor K3 Business Technology are up a shade on news of further contract wins in manufacturing division worth £0.5m. The statement also notes that trading remains encouraging. Document management software company Invu is undertaking a rather complicated reorganisation of its share capital designed to make it a UK company. US shareholders will be given cash for their shares and a newco called INVU Plc will become the listed entity (it is currently Invu Inc). Invu has also re-announced the launch of a beta version of a new product called Ergo. Ergo is described as a next generation (by which we infer web 2.0) search, clustering, visualisation and social networking tool. This look like a departure from the core business for Invu and we are hoping to speak to management in the next few days to understand more about the product and how it fits with the company's overall strategy. Invu shares have opened unchanged at 29p.

UK Technews - Friday roundup 2.11.07

It's a very quiet morning this morning so we'll move straight to the weekly roundup. Telecity's share price performance post IPO was the story of the week. The shares were up nearly 50% from their 220p IPO price at one point although some profit takers did come in yesterday. Nevertheless, the shares closed at 315p, over 40% up on the listing price. Whilst we were not at all surprised that the IPO got away, we were slightly surprised that its came at over £400m and even more to see the shares rise so fast once on the market. As we said in our recent article, Picks and shovels in the gold rush, Telecity is one of the very few stocks that is a clear play on one of the megatrends in the sector at the moment, namely software as a service (SaaS). We had anticipated some scarcity value in the IPO, but perhaps we underestimated just how much.

Just as one hosting company makes it onto the market, another prepares to leave. Intechnology announced that it will be delisting from AIM subject to shareholder approval providing more evidence, as if any were needed, of the visibility and valuation gulf between fledgling and mid/large cap stocks. You can read our piece on Intechnology's announcement here. Intechnology shares closed yesterday a shade below the 34p offer price suggesting that the bid will go through without any drama. Another stock showing strong gains this week was Fidessa where brokers have been getting excited about banks spending more with suppliers like Fidessa to get them through the MiFiD deadline. Whilst this seems like a logical argument in one sense, we do wonder slightly if it is a little shortsighted. Fidessa and others my benefit in the short term from MiFiD, but as with Y2K and Holway's famous Y2K hangover, could some of the banking stocks suffer from a MiFiD hangover next year? Anyway, Fidessa stock stormed ahead 13% this week to close at 1185p yesterday.

Other stocks firmly in the black this week were Morse which put on 14% over the week so far to 104p following an upbeat trading statement (update - it has been pointed out to us that a partial share consolidation has also had a positive impact on the price). Alphameric is up and down like the proverbial draws. Having given up much of the previous week's gains, the shares jumped up again 44% this week to close at 31p yesterday. We have to admit that we're not close to the situation but, with a bid approach in the offing, one can only assume that investors are speculating about the possible level of such an offer. Telecoms software vendor eServGlobal also had a good week following an upbeat trading statement to close yesterday up 9% on the week at 49p and The Innovation Group reacted positively to news of a contract win with Safe Auto Insurance in the US - TIG shares added 7% in the week to 34p.

In a generally positive week for the sector where stocks in our universe were up by 1.5% on average, there weren't too many losers. Video search specialist Blinkx was the worst performing stock in our universe this week by some margin as the maiden interims failed to excite - the shares closed at 28.5p last night, down 19% on the week. Readers will know that we have some concerns over Blinkx's competitive position with Google and you can read our thoughts on the results here. Shares in enterprise marketing software provider Alterian were 2% lower on the week following interims. Whilst the results were ahead of analyst expectations, there were no upgrades and we feel that the market has some concerns over the requirement for the company to accelerate revenue growth in H2 in order to hit full year numbers. You can download our Results Snapshot here. There were no other significant news driven losers last week but GB Group (down 9% to 24p), Emblaze (down 7% to 70p) and Netstore (down 6% to 27p) all suffered from small cap drift.

What's on next week?

It's a relatively quiet week next week and a couple of companies are taking advantage to have analyst teach in. The big one next week is Northgate Information Solutions which is taking analysts to Belgium to see recently acquired Arinso. In addition, the company will issue a period end trading update for its half year to October on Wednesday. Northgate shares have been stuck in a rut since the Arinso deal. The company's perception issues in the City have been further exacerbated by the credit crunch which makes its £500m debt pile look a whole lot more significant. The credit crunch also means that any private equity bid for the company above 100p per share (as was nearly the case last year) looks like a distant memory. Furthermore, it is widely believed that Northgate wants to sell its Managed Services and Public Sector businesses but it is clear that this would dilute EPS. All in all, we can see no easy way out of the current malaise. That said, given that the company will be in the spotlight with the analyst visit, it seems likely that the statement on Wednesday will be no worse than neutral. Northgate's statement kicks off the public sector IT reporting season where we should get a trading update from Idox shortly and Anite at the end of the month; Detica and RM are reporting on 19th November; Civica has interim results on 4 December and Anite, Northgate, Vega and Idox should report shortly after. All of these statements and results together should give us a very good idea of the outlook for public sector IT spending in the UK.

NCC Group is also giving an analyst teach in next week - on Tuesday. The company will be lifting the lid on its Assurance Testing Division. After a steep drop in the summer, NCC shares have recovered to near their all time high of 409p helped by an upbeat IMS recently. On the results front, document management technology vendor Dicom will announce Q1 results on Wednesday. Dicom has had a tough year following lacklustre full year results and a lack of leadership as CEO Rob Klatell announced his retirement. There is no word on a replacement although we are aware the search is well advanced. As one might expect, the shares have been under pressure but have been held up by an extensive share buy-back programme and the attentions of 28% shareholder William T Comfort III and his firm Conversion Capital which has fuelled speculation of a bid.

That's it. Have a good weekend everyone.

UK Technews 29.10.07

eWe're back from a week off and it seems that we didn't miss too much last week. The big news was the successful IPO of Telecity which some have taken as a sign of returning health to the IPO market following the failed listing of Smartstream a month ago. We see the differing fortunes of the two IPOs more as a comment on the relative merits of the underlying markets in which the two companies operate, rather than any improvement in underlying investor sentiment over the last few weeks. Telecity is a play on the SaaS megatrend and, since the removal of IX Europe at a big price, is the only significant hosting company listed in London so there is also a scarcity value. Nevertheless, the success of Telecity will probably give courage to some others thinking of having a go, but we still believe that investors remain highly selective.

There were two significant sets of results in the UK last week. The market initially reacted negatively to Autonomy's in-line Q3 results but the shares have since recovered to trade close to their 1000p high. The only other significant set of results last week came from Datatec which provided no surprises following a recent trading update - the US division of Logicalis seems to be steady now after some problems in the summer.

Across the pond, there has been a stream of positive news from the bellwethers most notably Microsoft, Google and Apple all of which were significantly ahead of expectations. We said recently that the Q3 reporting season in the US tech majors could determine the direction of tech stocks over here in Q4 and the US has certainly provided a following wind. Also in the US, everyone has got very excited about Microsoft taking a stake in Facebook valuing the company at $15bn - sticking to our principle that one should only write when one can add further value, we don't intend to add to the millions of words written on the story in the last few days.

Looking at this morning's news, Autonomy spin-out Blinkx has announced maiden interim results - see separate post. The shares have opened down 1p to 34p. Also announcing interims this morning is Clinphone which has reported revenues ahead 11.5% to £23.0m but, as highlighted in a series of warnings, profits collapsed in the period and the company only made a modest underlying profit of £0.4m compared to £3.1m in H1 fiscal 2007. Clinphone shares are up a shade this morning to 64.5p. Lastly, Sage has made a small acquisition in the form of UK based HR solutions provider KCS for £20m in cash.

McAfee Safeboot buy casts further doubt on European IPO market

We were interested to see the acquisition of Dutch security software company Safeboot by NASDAQ listed McAfee yesterday not so much for the deal itself but for what it says about the European IPO market. Private equity backed Safeboot provides full disk encryption systems for mobile data protection on laptops and PDAs and had only recently announced it's intention to undertake an IPO on Euronext.

Our View

The valuation paid for Safeboot at the $350m price tag was reported to be 28x current year earnings, so perhaps it wasn't a failed IPO so much as a more attractive offer from McAfee. Nevertheless, following on from the indefinite postponement of the SmartStream IPO, this news add further doubts to the attractiveness of the European IPO market. Hosting company Telecity is currently undergoing its IPO  and early rumours are that there is a generally positive view about the company but some resistance to the £400m+ price tag sought. Enterprise virus and anti-spam software vendor Sophos is also rumoured to by coming to the market shortly and will be particularly interested in the Safeboot news as it operates broadly in the same space. What seems increasingly clear to us is that, if Telecity doesn't get away, then the IPO market will effectively be shut.

Competition hots up for Telecity at the entry level

Amongst many interesting companies on show at the Future of Web Apps conference yesterday was Scottish hosting company XCalibre Communications which has just launched a new service called Flexiscale. Flexiscale is in direct competition to the popular Amazon Web Services offering which was launched a few months ago as a low cost hosting and storage service.

Whilst the Flexiscale launch is interesting, what is more interesting from our point of view is how it is symptomatic of increased competition in hosting at the entry level. In our recent post on Telecity we highlighted the 'picks and shovels' investment case and we retain this view. However, we also noted that the laws of economics suggest that an attractive market sucks in capital which is used to increase supply which inevitably puts downward pressure on pricing.

It is important not to get too carried away with this because Amazon Web Services is clearly targeted at the SoHo/SME market and we do not see it as a threat in the enterprise market for the time being. However, we do feel that potential investors might be interested to do more research on this area as it is an increasingly important component in the investment case for Telecity, in our view. For those wanting to read around the subject we suggest that you look at the following articles, blogs and companies.

Articles / blogs

Datacentreknowledge

Gigaom

Techcrunch UK

PC World

Techcrunch US

Symantec research (This one is actually a piece of research from Symantec on lack of availability of hosting space which we thought would also make interesting reading for Telecity watchers)

Companies

Amazon Web Services

Flexiscale or XCalibre

Nirvanix

Interxion

Apprenda

UK Technews 2.10.07

Better late than never, a quick round up of the day's news. First, Mediasurface shares are deep in the red after a bad profit warning - the shares are down over 50% (see separate post). Phoenix IT is also under pressure today following its trading update yesterday - the shares are down 6.5% to 350p. On a more positive note, Blinkx has said that current trading is ahead of expectations and that results for the first half to September will beat the top end of expectations. The shares are up 16% to 34p.

The SmartStream IPO bandwagon came to a sad end yesterday as the company announced that it had delayed its IPO indefinitely. This follows news on Friday that the company was going to give it a couple more days to see if they could fill the book. However, according to the FT, the company's hand was forced by the SEC which was unhappy about the IPO being finalised so close to the SIBOS trade show where SmartStream management would be making presentations. Even without that though, news of massive losses at Citigroup and UBS resulting from sub prime mortgages may well have been the last straw anyway. It's always a shame when IPOs don't get away but it will be interesting to see whether TA Associates, who have only owned SmartStream for a year or so, stick with it or look for a trade exit. We watch with interest to see whether Telecity gets a warmer reception and whether others that are rumoured to be trying for an IPO, such as Sophos, carry on with their plans.

We've just spotted that Anite has replaced UBS as its broker with JPMorgan Cazenove and Landsbanki as joint brokers.

We're at the Future of Web Apps (FOWA) conference tomorrow which should be really interesting. At a time when Web 2.0 is attracting so much attention, this event brings together many of the top people making it happen as well as some very funky start ups.

Telecity - picks and shovels in the gold rush

Somehow we managed to miss the news of Telecity's intention to float yesterday although it is no big surprise as it had been rumoured for a while. The group, which includes Telecity, Redbus and the former UK and European operations of Globix is said to be looking for a valuation of £400m - £500m. Revenues in H1 were £46m and EBITDA was £10.3m. John Hughes of Intec Telecom Systems (amongst other roles) has joined the board as Chairman. Deutsche Bank is leading the IPO and Deutsche and Citi (fresh from SmartStream) are joint bookrunners.

Our View

In web 1.0, there was much talk of investing in picks and shovels in the goldrush. Put another way - some argue that the best way to make money in a gold rush is to sell picks and shovels to those hunting for gold rather than take the risk of hunting for the gold yourself. For us, this is the fundamental investment case for Telecity. There has been much excitement about the advent of web 2.0 and SaaS (software as a service) but the bottom line is that both of these megatrends require significant amounts of hosting capacity to make them happen. We are therefore sold on the market backdrop to this IPO. Also, from a business model perspective, mature hosting businesses like Telecity have highly visible earnings and high margins. Furthermore, cash flow from existing operations is strong although, clearly, growth is capital intensive. Add to this investment thesis the fact that capital investment (as well as things like planning restrictions), creates high barriers to entry and you have a pretty compelling investment case. On the negative side, the one thing that any investor should fear more than anything in a hosting business is overcapacity, as was the case in 2001-2003. Whilst we do not see this as an issue in the short to medium term, increasing availability of capital for hosting business means that capacity is likely to grow rapidly over the next few years.

Another point to note about the resurgence of Telecity is the inevitable grumbling about how the private equity backers (in this case 3i) have made a killing. Telecity and Redbus were taken off the market for peanuts as recently as 2004-2005. To our mind, this is not an example of the public markets being raped by private equity but actually a classic demonstration of why, for the most part, private equity funds perform better than quoted funds. Any observers complaining about private equity profiteering should consider that they were the only ones prepared to take a bet on hosting at a time when most UK institutional investors wouldn't touch it with the proverbial barge pole. To be clear, we are not aiming to run down UK institutional fund managers - more the system of quarterly performance that prevents them from taking a longer term investment view.

Turning to valuation, despite all of our glowing words about the company, to our mind, the top of the range looks a little rich although we should caveat that comment by saying that we have not seen broker estimates for the company. But to use the tried and tested back of a fag packet method, given some H2 growth, an estimate of around £25m of EBITDA for the current year looks reasonable. If we assume that that grows by 20% next year, we get to £30m. There are no meaningful UK comps but IX Europe was taken out (by Equinix) at around 15x 2008 EBITDA. Putting Telecity on a similar multiple would imply a valuation of around £450m. However, valuing an IPO at the multiple of an M&A transaction is perhaps a bit punchy so we would argue that the lower end of the range may leave something on the table for the next man. We watch events with interest.