Digex Inc.: Cleared For Takeoff

Under WorldCom's wing, Digex could reach new heights.

WorldCom is betting that it can lose Sprint but still win the data race.

Indeed, WorldComs recent $3 billion acquisition of Intermedia Communications includes controlling interest in Digex—a fast-growing provider of Internet data centers. WorldCom had hoped to acquire Sprint and its wireless services, but federal regulators blocked that deal last year.

Digex will figure prominently in WorldComs data strategy. In recent months, WorldComs voice revenue has been sliding, making a data push all the more critical.

The FCC cleared WorldComs Intermedia buyout on Jan. 17. In effect, WorldCom now owns 55 percent of Digex.

WorldCom hopes to marry its sales force and global IP network with Digexs data centers. "With this merger, WorldCom accelerates by 12 to 18 months our ability to provide world-class managed Web and application hosting services— one of the highest growth markets in the industry," said WorldCom president and CEO Bernard J. Ebbers, in a prepared statement.

Indeed, Digexs revenue and customer base grew rapidly through Q3 of last year. The company will announce Q4 results on Feb. 1. Some analysts are worried about a short-term slowdown in the overall IT market, but Digexs future looks bright. International Data Corp. predicts that the Web hosting market will be an $18.9 billion market by 2003, up from less than $1 billion in 1998.

A Few Caveats Still, the WorldCom-Intermedia deal has its challenges. Some of Digexs minority shareholders have sued five Digex directors, along with WorldCom and Intermedia. The plaintiffs allege that WorldCom planned to buy Digex on the open market, but ultimately used Intermedia as a middleman to gain control of Digex for a lower price. A three-week trial is set to begin May 14. WorldCom and Intermedia could be forced to pay undisclosed damages if they lose the case.

Meanwhile, Digex faces a few of its own hurdles. Despite impressive revenue growth, Digexs quarterly losses are mounting (see charts below), and the company trails Internet giant Exodus Communications in the data-center market. Exodus has yet to generate a profit, but its EBITDA (earnings before interest, taxes, depreciation and amortization) recently moved into the black. EBITDA at Digex, by contrast, remained in the red through Q4, and the company isnt expected to have positive EBITDA in Q4.

Californias rolling blackouts and brownouts also are cause for concern. Digex, Exodus and other data-center operators say they have installed redundant power feeds, multiple diesel generators and other emergency gear to maintain operations during a power failure.

Awesome Allies Digex brings plenty of partners to WorldComs table. In Q3, Digex began to work more closely with e-business software specialists like ATG, Bea Systems, BroadVision, IBM (WebSphere) and Vignette. The company also has a close working relationship with Mi8, a New York-based ASP that specializes in hosted e-mail.

Digexs most critical allies, however, are Compaq and Microsoft, which invested a combined $100 million in the company last January. Digex, Compaq and Microsoft are designing hosted services based on Compaq servers and storage; Windows 2000, Exchange Server and SQL Server; and Digexs own managed services.

Now, if only Digex could turn a profit.