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Cable & Wireless snaps up Digital Island

British telecommunications company Cable & Wireless Monday snapped up Digital Island for $340 million with plans to merge the two companies' global networks to create a larger, more comprehensive Internet Protocol backbone for business clients.

Shares in Digital Island (Nasdaq: ISLD) were up 22 cents to $3.35 in early trading Monday. The company operates a global private network that provides hosting, content delivery and networking to business customers looking to bypass Internet congestion.

Its stock traded as high as $148 a share in December 1999 before crumbling along with other Internet-related stocks. Digital Island shares surged last week after the company announced a deal to host Microsoft Network's advertising.

Cable & Wireless, which trades on the London stock exchange, is a traditional telecommunications company that is making the move into business data and Internet services. The company has been on a buying and selling spree, ridding itself of business units and snapping up Internet service providers across Europe.

Monday's all-cash transaction values Digital Island shares at $3.40 each. The $340 million price tag includes $49 million of debt.

Once the acquisition is completed, Digital Island will become a wholly owned subsidiary of Cable & Wireless. Digital Island will remain based in San Francisco with its current management team.

The merger will combine Digital Island's infrastructure and content distribution services with that of Cable & Wireless, bringing cost benefits as well as revenue growth. Though the acquisition will dent the earnings of Cable & Wireless in the near term, it is expected to add to earnings by the end of the third year, the companies said. The deal is also expected to improve EBITDA (earnings before interest, tax, depreciation and amortization) and EBITDA margins.

As reported in Digital Island's second quarter, revenue for the year ending Sept. 30 is expected to be in the range of $140 million to $145 million. The company also said in its second-quarter release that it was cutting 22 percent of its work force.

The agreement with Cable & Wireless prohibits Digital Island from soliciting a competing offer, and the companies expect the tender offer to close in about 30 days.

Rival Data Return (Nasdaq: DRTN) got a boost out of the Digital Island deal Monday, as shares rose 14 cents, or 6 percent, to $2.67. "The valuation implications (of the Digital Island deal) could create a Data Return trading opportunity today," wrote C.E. Unterberg Towbin analyst William Dering in a research note.

"We suspect Data Return would be the easiest managed hosting company for a potential acquirer to integrate," he added.