London firm buys Digital Island for $340 million

By Frank Cho and John Duchemin
Advertiser Staff Writers

London-based Cable & Wireless Plc agreed to buy Digital Island Inc., a provider of Internet services to corporations, for $340 million in cash and debt.

The purchase ends the state's four-year investment in what was once one of Hawai'i's most promising start-up high-tech companies.

Digital Island, founded in Honolulu and now based in San Francisco, will become a wholly owned subsidiary of Cable & Wireless. The London company offered to pay $3.40 a share, or 8.6 percent more than Friday's closing price, and assume $49 million in debt.

Digital Island's share price has been in free fall since it topped out at $156.94 on Dec. 10, 1999, giving the company a market value of more than $8 billion. The state, through its Strategic Development Corp., bought more than 300,000 Digital Island shares in 1997 for an average price of $1.43 per share.

The state can expect to receive about $775,000 for the 228,000 shares it still holds. When added to earnings from shares sold earlier, the state will see about a $2 million return on its $450,000 investment in the company, far below the $30 million to $40 million it expected to reap after the company went public in June 1999.

"It's a modest premium, but we will be able to cash out and provide some distribution to the state," said John Chock, of the Hawaii Strategic Development Corp., which supports technology development in Hawai'i.

Digital Island was founded by entrepreneur Ron Higgins and funded by a mix of local and national investors, including the state and Bank of Hawai'i. The company went public on June 29, 1999, selling for about $12 per share.

It has about 850 employees and, while it has yet to earn a profit, it expects revenue of $140 million to $145 million in the year to Sept. 30.

After the initial share sale, the stock price hovered around $25 per share for months and then began a course all too familiar among Internet start-ups.

First came an announcement that Digital Island had purchased Sandpiper Networks Inc. for $630 million in stock in October 1999. Digital Island shares rose as high as $75 that month.

Next Digital Island said on Dec. 8, 1999, that Sun Microsystems Inc., a maker of server computers, and Inktomi Corp, a software application company, had agreed to invest in the company. Share price jumped from $59.50 on Dec. 7, 1999, to $145.13 on Dec. 9 and peaked on Dec. 10.

But the share price fell as insiders — including Higgins — began to sell part of their holdings later in December. The price never recovered.

Higgins could not be reached for comment yesterday.

This month, Digital Island's chief financial officer resigned and the company said it would cut about 10 percent of its work force, after eliminating 11 percent since the start of the year.

Ruann Ernst, the company's chairwoman and chief executive, said Digital Island had enough cash to last five more quarters. She said she is looking for $150 million in additional money and has started to seek investors. While in talks with Cable & Wireless about making an investment, the London company became interested in acquiring Digital Island outright, Ernst said.

The purchase by Cable & Wireless, which is subject to regulatory approval, is expected to close in 45 to 90 days, Ernst said.

Ernst, who will stay on as the company's president and chief executive officer, said no further job cuts are planned.

Analysts said some dissenting shareholders may hold out to try to negotiate a higher sales price, but the state was unlikely to join them.

Many Internet companies have seen their stock prices plummet in the last year as investors shy away from companies with little or no earnings, such as Digital Island.

On May 1, Digital Island reported a second-quarter loss of $1.19 billion or $15.11 a share. The loss included a $1.04 billion charge for acquisitions.

Digital Island offers Internet services such as managed hosting and content delivery for business customers. Large corporate customers account for about 70 percent of its revenue, with the balance coming from small and medium-sized enterprises.