Deal Mechanic: Adapt reprogrammed

When UK mid-market firm Lyceum Capital acquired Adapt in September 2011 for an enterprise value of £30 million ($37 million; €35 million), its goal was to transform the London-based colocation data centre business into one that offered managed cloud services (MCS) at higher values and margins.

Before Lyceum’s £18.5 million initial investment through a management buy-in and a further £7.5 million of capital plugged in along the way, the business focused on reselling data centre space and networks and only had three hosting clients. At that time, MCS accounted for less than 10 percent of total sales.

Lyceum had spotted a trend in the US where businesses in the same sector were moving from selling data-centre space to owning servers and providing managed hosting services.  “In 2010, that hadn’t really manifested itself at scale in the UK,” says Simon Hitchcock, Lyceum’s investment partner on the Adapt deal.

Through market mapping and talking with “as many owners and chief executives in the sector that would take a meeting”, it became clear that hosting cloud services presented a huge opportunity. Lyceum identified cash-generative Adapt as the platform through which to expand into a market that was growing at 15-25 percent a year.

1-SHAPE-SHIFTING
The acquisition of Cardiff-based MCS business eLINIA in April 2012 for an enterprise value of £13 million kicked off Adapt’s makeover. “We saw an opportunity to build a UK-managed hosting business and we knew that to do that we needed to be able to position it to attract the right customers and have the technical ability to deliver,” says Hitchcock.

eLINIA’s staff of 50 provided a “real engine of technical people”, says Hitchcock, who notes professionals with the same skillset were in short supply in London – and expensive. Supported by recruitment grants from the Welsh government, London-based technical staff moved to Cardiff where the team grew to 110 people over five years.

“[The eLINIA acquisition] was the cornerstone of the transformation from a technical capability and delivery point of view. It saved us probably three years [of] building a team and capability,” Hitchcock says.

This was followed in June 2013 by the purchase of Leeds-based cloud hosting provider Sleek. The buy extended Adapt’s client base to smaller businesses with more “nimble” hosting needs and allowed Adapt to provide “a more flexible, lower-cost solution, which meant we could address a larger part of the market at a lower price point and then take some of those customers on a journey to become larger”, Hitchcock says.

2-GOING TO MARKET
With the technical capability in hand, the company could focus on its commercial strategy. While mapping the market the Lyceum team had met Stewart Smythe, then at Cable & Wireless Communications, who invested alongside the GP and came on board in January 2012 as chief executive.

“Stewart was fundamental to the strategy and instrumental on the go-to-market side, positioning the business as being the best to look after mission-critical data, winning the first landmark hosting client – who frankly took a risk on our ability to deliver – delivering well for them and then using case studies for the next client,” Hitchcock says.

Significant contracts included flower delivery service Interflora and, later, convenience food retailer Greencore Group.

As the demand for managed hosting became more established “it became about having a really efficient sales and lead generation machine, and consistent first-class delivery”, says Hitchcock. To that end, Adapt brought in an additional non-executive board member to sharpen the commercial effort based in London.

3-MAKING IT SEAMLESS

The CEO’s ability to “knit it all together” was key to the success of the business, says Hitchcock. “Adapt was a buy-in with M&A in an emerging and growing market. Making the whole thing work so the client delivery was really excellent was key to success.”

The company was a service business and the technology was “pretty standard” and less of a challenge than getting right the “service wrap” – the people, systems and processes that hung around it – says Hitchcock. “There was a lot of change in the business over the five years and we were invested in getting it right. Working with the CEO we had to change a couple of members of the management team and strengthen the team with additional roles.”

Keeping ahead of market trends remained a theme. Two and half years ago, on a visit to the US, Hitchcock and Smythe recognised more hosting clients were using hyperscalers – which accommodate increasing computing demands – for some of their applications, and Amazon Web Services was leading the charge.

Anticipating future client needs, Adapt hired a technical team to support its AWS offering and funded the development of a platform. By the time of exit in August 2017, its first two customers had gone live. “AWS was a reaction to what was happening the market, a natural evolution,” says Hitchcock. “The buyer [Datapipe] has quite a large AWS business, so that will continue.”

4-LEGACY ISSUES
Such significant business transformation was inevitably met with challenges. Foremost, margins in the original colocation data centre business contracted more rapidly than anticipated.

“The hosting business outperformed our expectations and the colocation reselling, which we thought was a stable business, underperformed,” says Hitchcock.

“At one point we’d got a business where one side [MCS] was growing at 40 percent a year, but the other side was declining. Managing and understanding that dynamic was something the management had to deal with. It was the key challenge.”

The disparity meant Adapt took longer to reach the £10 million EBITDA threshold at which Lyceum planned to sell, and the GP’s exit was delayed by a year to 18 months.

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By exit, the heavy lifting was done and managed cloud services represented closer to 70 percent of sales. Adapt had also expanded its MCS market share from £300,000 a month in September 2011 to more than £3.4 million by July 2016, with revenues for the sector growing 20 percent in the last year of investment.

Annual revenue grew from £32 million for the year ending 30 June 2011 to £45 million in June 2016, and EBITDA from £3.7 million to £10.1 million. Employee numbers had swelled from 100 to 210.

Following an off-market approach at a premium to other interested parties, US-managed hosting and cloud services provider Datapipe, in which Abry Partners is an investor, acquired the company. The sale generated a money multiple of 3.2x for Lyceum.

£3.7m EBITDA on entry 
£10.1m EBITDA on exit
3.2x return
<10% sales made in managed cloud services on entry
70% sales made in managed cloud services on exit