Webcentral: A fantastic deal

Last night, Webcentral (ASX:WCG) announced a deal that took the market by surprise, selling two thirds of their domains business for an implied value of A$165m. Far less surprisingly, the stock was up a lot today.

We’ve been a very public supporter of WCG for many years now, going back to 2020 when we blocked the takeover of WCG, and then again prior to that in the 5G Network days shortly after IPO. 5G Networks, which went by stock code 5GN, was one of the first stocks we bought in Capital H Inception Fund when we set up in June 2018.

While we did not hold shares in the fund just prior to the deal we bought a lot on the open this morning, and we certainly benefited as 5GN rose from 40c to $2, and WCG went from 15c to 60c, and we want to give credit where credit is due for a fantastic deal by the management team of WCG. We’ve also had many Livewire readers ask us for our views on WCG over the last 12-18 months, so this is a good opportunity to do that.

The Deal

WCG is selling 2/3 of the Webcentral domains and hosting business to European PE firm Oakley Capital, and partners, for $115m in cash. They will retain 1/3 of the domain and hosting business and all the 5G Networks business. The deal is still subject to equity and debt financing, though Oakley are a massive firm (€10b AUM) so would assume this is low risk.

After paying off all debt and costs of the deal, WCG will clear about $84m in cash, subject to adjustments. The 5G business, which consists of data centres, managed services and telco, will be profitable.

Note: there was no clear statement made on any tax payable on the proceeds. Our numbers here assume no tax, but investors should track this closely.

The 1/3 ownership in the domains business will leave them with upside from partnering with a group that has a long history of successful ownership and operation of similar assets. This provides WCG shareholders with optionality over the continued success of this business.

The $165m Question

With WCG trading on a sub $40m market cap just prior to the deal being announced, the headline numbers for this transaction look phenomenal. It’s worth considering how such a value can be achieved.

The first, more general answer is the currently enormous disconnect between microcap valuations in Australia and what private capital is willing to pay for them. WCG is not the first microcap to receive a bid at a massive premium recently, and we’re betting our money that it won’t be the last.

The second is that the value in the domains business is very large, to the right owner. These are akin to annuity assets, and an important ‘first sale’ to a customer starting their online journey, allowing many other products and services to be upsold (hosting, email, security, managed services, internet, etc).

The cashflow is beautiful too. When you buy a domain you pay upfront, typically for several years. WCG, and similar operators, get that cash up front and deliver the service (i.e incur most of the expenses) over the life of the contract.

It’s also true that the most recent financials hid the earnings power of the domains business. Oakley are paying 9x EBITDA, which is a multiple we’ve always felt is quite reasonable. It’s just that it wasn’t plainly obvious in the last few sets of accounts that domains and hosting was generating $18m of EBITDA by itself.

There was also the debt. In an environment of rapidly rising rates the relatively highly geared balance sheet ($31m debt) worried a few, myself included if I’m honest. This depressed the share price far more than was reasonable. For many, it would have been put in the too hard basket.

But it seems in hindsight that management understood the assets, knew what they could sell them for and felt comfortable running it at those levels of gearing.

What’s Left Post Transaction?

The first important point would be that it is not yet a done deal. It is still conditional on equity and debt financing being sorted, so proceed with appropriate caution, but for the sake of this section we’ll assume it completes – the odds are in WCG’s favour.

WCG will still own 1/3 of the domains and hosting business, which will have an implied value of $20m. The public market tends to not fully price minority holdings, so don’t expect it to be fully reflected in the share price, but there’s definitely optionality here. Perhaps the remaining 1/3 is later sold for cash, or the domains business is listed again on an overseas exchange where investors are more likely to fully value the assets.

The remaining business will be 5G Networks, the business we first bought into back in 2018 and backed the management team for many years. It provides managed services, fibre and data centres to enterprise and business customers across Australia, generating about $45m in revenue. WCG have stated the remaining business will be profitable to the tune of $5m NPAT, which would include after tax interest on the $80m+ cash balance.

Our estimate of reported EPS going forward is below, but we’d note it is guesswork until further details come out.

There will be a big pile of cash, about 25c/share according to the company, subject to working capital adjustments on closing of the deal. With the share price trading around those levels this morning we saw upside if and when the deal closes and the cash is received.

All the above will leave the company in a good position to pay dividends, though there’s been no clear statement on this just yet. The history of this management team is acquisitive, so shareholders should expect the cash to be used for M&A. Their success with this acquisition should give them the right to have another crack at it with all that cash, as the WCG acquisition in hindsight now looks like a screamer.

And then, assuming the deal closes as expected, the company will complete the circle and the name will be changed back to 5G Networks.

Well done Joe and team for executing on a fantastic deal, and I hope some Livewire readers made some money out of our wires over the years.

If you missed this one, take this as motivation because there are certainly other similarly undervalued microcaps out there today. Time to find the next one.