Digex, Inc.

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Digex, Inc.

14400 Sweitzer Lane
Laurel, Maryland 20707
U.S.A.
Telephone: (240) 264-2000
Fax: (301) 847-5215
Web site: http://www.digex.com

Public Company
Incorporated: 1991
Employees: 1,455
Sales: $168.1 million (2000)
Stock Exchanges: NASDAQ
Ticker Symbol: DIGX
NAIC: 514191 On-Line Information Services; 541513 Computer Facilities Management Services; 541611 Administrative Management and General Management Consulting Services

Digex, Inc. began the 1990s as an Internet service provider (ISP). Its enhanced data services made it a desirable takeover target for larger telecommunications companies, and in 1997 Digex was bought by competitive local exchange carrier (CLEC), Intermedia Communications, Inc. With Intermedia as its parent company, Digex expanded its Web hosting capabilities and became a separate public company in 1999, with Intermedia retaining control of the company. When Intermedia was acquired by long-distance carrier WorldCom, Inc. in 2001, Digex became a key component of WorldCom’s business plan.

From ISP to Web Host: 1991–98

Digex, Inc. was founded in 1991 by Doug Humphrey, a Maryland entrepreneur, as an Internet service provider (ISP). By 1995, sales had reached $10.7 million, and Digex made plans to go public. Humprhey hired Chistopher McCleary, a telecommunications executive, as CEO, with Humphrey remaining as chief technology officer. In October 1996 Digex held its initial public offering (IPO) at $10.13 a share.

In June 1997, Intermedia Communications Inc., a competitive local exchange carrier (CLEC) that offered local and longdistance telephone service in competition with the regional Bell operating companies (RBOCs), announced that it would acquire Digex for $150 million, or $13 a share. From Intermedia’s point of view, Digex was a desirable strategic acquisition because of its enhanced data services. At the time Digex was providing Internet access as well as Web site management and hosting services to more than 2,000 customers. Its first quarter revenue in 1997 was $8.7 million, and the company had 450 employees. Following the acquisition, Christopher McCleary remained as Digex’s chairman, president, and CEO.

Later in 1997, Digex expanded its Web hosting capabilities by opening a second data center in Cupertino, California, to complement its original data center in Beltsville, Maryland. The new data center offered high availability through Web servers in different geographic locations. As a result, data would be delivered more quickly to Web site visitors. The second data center also added load balancing and site mirroring for Digex customers.

For the rest of 1997 and 1998, Digex gained high-profile corporate clients for its Web hosting services. When Martha Stewart Living (www.marthastewart.com) launched in September 1997, it was managed by Digex. Site traffic was estimated to be 2,000 concurrent users and 6,000 hits per minute, requiring Digex to add more servers. Other clients included J. Crew, Kraft, Mercedes-Benz, and Nike. Digex’s strategy was to focus on larger organizations with well-defined needs and to provide them with a high level of customer support. According to Network Computing, Digex’s customers reported a high level of satisfaction in the area of problem resolution.

At the 1997 Internet World trade show, Digex introduced three new Web hosting services: Insurance Server, Distribution Server, and Disaster Server. The Insurance Server provided failover support when a customer’s server went down, regardless of where the server was located. Distribution Server utilized Digex’s data centers in California and Maryland and provided customers with a Web server at each location. Visitors to customers’ Web sites would then be routed to the closest server, thus reducing response time for site visitors and providing backup in case of an outage. The Disaster Server provided customers with backup within a guaranteed number of hours. It was designed for customers who did not want to administer two separate Web sites.

Also at Internet World, Digex introduced a new testing service that allowed customers to beta test their Web site in a production environment for a discounted fee. In addition, the company created a professional services group to expand its consulting services. Digex consultants would work with business customers on the development, testing, implementation, and maintenance of their Web sites. Specific services that were offered included developing an architecture and planning the site, stress testing, site migration planning, high-availability design, and performance analysis and tuning. By mid-1998 Digex had finished building its Web site performance testing lab, enabling the company to work with clients before and after they launched their Web site. The testing lab allowed stress testing a site to determine when and why it would go down.

Digex Spin-Off: 1999

At the beginning of 1999, Digex was focused on Web hosting and was operating more than 1,000 servers. Its plans called for the construction of additional data centers in the United States and Europe. In five years the company expected to be operating more than 20,000 servers. At the time, the market for Web hosting was projected to reach $15 billion in 2002, according to a study by Forrest Research, compared to less than $1 billion in 1998. In mid-1999, Digex moved into a new headquarters with 109,000 square feet and triple the Web hosting capacity of its previous headquarters. It was around this time that Mark Shull joined Digex as president and CEO. He was formerly in charge of GTE’s Web hosting business unit.

In mid-1999, Intermedia spun off Digex as a public company, offering 49 percent of the company’s stock to the public. There was a high degree of interest among investors in Internet-related companies at this time, and it was expected that going public would increase the value of Intermedia’s investment in Digex. Digex’s revenue had grown from $2.8 million in 1996 to $22.6 million in 1998, and revenue for the first quarter of 1999 was $9.4 million. Digex had yet to turn a profit, showing losses of $16.5 million in 1998 and $22.9 million in 1997. It had about 550 top-tier clients and operated some 1,300 servers. Following the IPO in mid-1999, Digex’s stock rose to a high of around $160 a share in March 2000. From its peak, though, the stock tumbled over the next two years and was trading in the $2 to $4 range at the end of 2001.

For the rest of 1999, Digex introduced new, enhanced services. These included the SmartSecurity service, which monitored security information sites and sent e-mail notifications to customers when a security threat, such as a computer hacker, was detected. SmartBackup, another new service, guaranteed data recovery in four hours, compared to previous guarantees of two days. Digex also offered a SmartReporting service for both Windows NT and Sun Solaris servers. SmartReporting allowed Digex’s clients to access Web site activity logs and see what their own customers were doing at their Web sites. SmartMonitoring was a new service that alerted Digex to any performance problems, and SmartAdmin gave Digex more network, software, and hardware administration capabilities.

Web Hosting Makes Digex an Acquisition Target: 2000–2001

At the beginning of 2000, Digex hosted more than 600 corporate Web sites and managed more than 2,000 application and database servers. Approximately 80 percent of the company’s revenue came from Web hosting, another 15 percent from application service providers (ASPs), and about five percent from consulting. Digex’s ASP business involved partnering with developers to bring more applications to the Web rather than competing directly with other ASPs. Digex provided an enabling platform and operations for its ASP partners, who then would market to their enterprise customers. Digex also offered its ASP partners the ability to test the reliability of their Web-enabled applications before offering them directly to corporate customers. Around this time Microsoft, Compaq, and Sun Microsystems were all making substantial investments in the ASP market. In January 2000, Microsoft and Compaq jointly invested $100 million in Digex to develop application hosting services using Microsoft software platforms and Compaq servers. The ASP market was projected to reach $22 billion by 2003, according to PC Week.

By 2000, Digex had gained recognition as an industry leader in Web hosting services through its high-profile clients. Its ad campaigns focused on well-known Digex customers such as J. Crew, Martha Stewart Living, Fila, and TWA. Network Computing magazine included Digex among the top Internet service providers. In mid-2000, the company launched a $7 million ad campaign that featured basketball star Shaquille O’Neal. The company also received a $4 million grant from the state of Maryland to create more than 1,000 jobs over the next four years.

In September 2000 WorldCom Inc., the second-largest longdistance telephone company in the United States, announced it would acquire Digex’s parent company, Intermedia Communications, for $6 billion, including $3 billion in stock and $3 billion in assumed debt. WorldCom’s bid for long-distance provider Sprint had been denied by regulators two months prior to its announced acquisition of Intermedia. The primary reason for WorldCom’s interest in Intermedia was Digex and the higher profit margins associated with Web hosting services.

Company Perspectives:

Digex has been offering managed hosting solutions to our clients for years. During that time we’ve seen such a dramatic and rapid transformation of business on the Web, starting with simple static sites moving to large-scale transaction processing engines. We are now approaching an even more exciting era of Internet computing and we intend to be right there with our clients, helping to lead the way.

WorldCom’s acquisition of Intermedia, which would not close until July 1, 2001, gave WorldCom control of Digex. Intermedia owned 55 percent of Digex’s equity and controlled 94 percent of the company’s voting interest. The acquisition marked WorldCom’s entry into the Web hosting market, where Digex’s Web hosting services would complement WorldCom subsidiary UUNet Technologies’ managed services offerings to corporate customers. The acquisition accelerated WorldCom’s ability to roll out new managed services by a year to a year-and-a-half. Although Digex already owned its own Internet network backbone, UUNet operated one of the most widely deployed Internet networks in the world, with more than 2,500 points of presence providing Internet connectivity in more than 100 countries. Digex also gained direct access to WorldCom’s 28 data centers then under construction. Around this time Digex moved its headquarters from Beltsville to Laurel, Maryland.

The results of Digex’s alliance with Microsoft and Compaq were unveiled in October at the Internet World show in New York. The new managed hosting platform, dubbed xFrame, was built on Compaq servers and Microsoft software. It enabled customers to access XML-based data from any of Digex’s four data centers worldwide and let software developers write Digex-enabled applications. The xFrame platform remained in beta testing with about ten customers before it was more widely deployed in January 2001.

Mydigex.com, a new portal for Digex customers, was also scheduled to debut in January 2001. It provided Digex customers with access to a wide range of information, including server performance statistics, traffic use, bills and invoices, asset management, new orders, upgrade status, and more. Basic services were offered to customers at no charge, with advanced services such as high-level reporting metrics and stress testing having a fee. Analysts viewed the new portal as an attempt to improve customer relationships by offering value-added services and overcome the reluctance on the part of some enterprises to outsource more of their Web sites and applications.

Before the end of 2000, Digex launched a new data center in London, England, as the first stage of its plan to enter the European market. Although WorldCom’s takeover of Intermedia was not yet complete, WorldCom formed a partnership with Digex and added Digex’s managed hosting services to its expanded Web hosting product suite. Among the Digex managed services included in the deal were site architecture and configuration, leased hardware and software, server monitoring, and backup and recovery.

For the year 2000, Digex’s revenue increased 181 percent, from $59.8 million in 1999 to $168.1 million in 2000. However, its losses also increased substantially, from $65 million in 1999 to $143 million in 2000. The company reported that it did not expect to reach profitability until 2003.

WorldCom Takeover: 2001

During the first quarter of 2001, Digex prepared for the anticipated acquisition of Intermedia by WorldCom by rolling out its infrastructure and operational standards at the WorldCom data center in Virginia. Digex’s first quarter revenue more than doubled to $52.1 million, compared to $25.8 million for the first quarter of 2000. The company’s loss grew from $25.6 million in the first quarter of 2000 to $44.2 million in the first quarter of 2001. Despite first-half losses totaling $57.8 million, Digex actually expanded its workforce by more than 100 workers in the first half of 2001 to 1,455 employees.

Meanwhile, the U.S. Department of Justice ruled that it would allow WorldCom to acquire Intermedia, but WorldCom would have to sell all of Intermedia’s assets except Digex. That ruling was later modified to require WorldCom to sell all of Intermedia’s Internet assets. In January, the Federal Communications Commission (FCC) approved the takeover and endorsed the Justice Departments stipulations. In March, a Delaware court approved WorldCom’s settlement of a lawsuit brought by Digex’s minority shareholders. Under the terms of the settlement, WorldCom agreed to give Digex shareholders about $165 million worth of WorldCom stock, with half going to shareholders of record on September 1, 2000, and the other half to shareholders of record when the acquisition closed. WorldCom also agreed to pay up to $250 million to cover Digex’s expenses and to provide $900 million in loans to Digex.

WorldCom’s acquisition of Intermedia closed on July 1, 2001. The deal was valued at $4.1 billion due to a drop in the value of WorldCom’s stock since the acquisition was first announced. It was clear that Digex, which would remain a stand-alone company, was a key part of WorldCom’s business plan. WorldCom planned to reduce its reliance on long-distance voice revenue and increase its presence in the lucrative data and Internet services business. With WorldCom’s financial backing, Digex planned to expand its capacity and enter new markets with very low levels of capital investment.

Principal Competitors

AboveNet Communications, Inc.; Digital Island, Inc.; Exodus Communications, Inc.; Genuity, Inc.; GTE Corp.; IBM Global Services; Verio Inc.

Key Dates:

1991:: Digex is founded as an Internet service provider by Doug Humphrey.
1996:: Digex becomes a public company.
1997:: Digex is acquired by Intermedia Communications, Inc. and begins offering Web hosting services.
1999:: Digex is spun off from Intermedia and becomes a separate public company.
2000:: Worldcom announces it will buy Intermedia for $6 billion in order to gain control of Digex.
2001:: WorldCom’s acquisition of Intermedia closes, with conditions imposed by the U.S. Department of Justice.