Update: WorldCom to Buy Intermedia for About $3 Billion in Stock

Updated from 8:23 a.m. EDT

Moving to gain control of Digex (DIGX Quote), a Web hosting company, WorldCom (WCOM Quote) announced Tuesday that it would acquire Intermedia Communications (ICIX Quote), a telecommunications operator, in a stock deal valued at about $3 billion.

But Brad Burns, a spokesman for WorldCom, said, "We're not acquiring Digex outright."

The deal dashed some investors' hopes for a premium on the shares of Digex, which is majority owned by Intermedia.

In a conference call with analysts and shareholders held after markets opened, officials of both companies rushed to assuage fretful investors. Shares of Digex settled down $16.63, or 20%, at $67.88, near its session low of $67.5. It hit a session high of $79.5. The volatile trading followed gains in Digex's price after Intermedia put the unit up for sale in early July.

"There might have been some anticipation that there might have been a deal that would have taken out the whole public float of Digex," said Michael Turits, analyst for Prudential Securities. "Those shareholders may be disappointed today."

Turits, who rates Digex shares a strong buy and whose firm has done no underwriting for the Beltsville, Md.-based company, said the acquisition, though a letdown for solicitous shareholders, will prove positive over time. "It means that the company is solidly capitalized, which could be important for a company that still needs to build out data centers."

WorldCom said it would exchange $39 of its stock for each Intermedia share, subject to a collar on the price. That represents a premium of $16.13 a share over Intermedia's closing stock price Friday. In addition, Clinton, Miss.-based WorldCom will assume $3 billion in debt.

Intermedia's shares finished up $8.48, or 38%, at $31.48. WorldCom's shares were down $3.19, or 9%, at $33.75.

The Intermedia deal is WorldCom's largest since it scuttled plans to buy Sprint (FON Quote) in an enormous deal that raised objections from regulators.

While WorldCom plans to take advantage of some of Intermedia's local phone assets, the company is likely to sell off redundant assets, The Wall Street Journal reported. Aside from those and a significant debt load, Intermedia has 54% ownership and 92.5% voting control of Digex.

John Stupka, president of WorldCom's Ventures & Alliances Group, said the company will leave the remainder of the ownership stake floating publicly for strategic purposes. The purchase helps WorldCom to both "accelerate our skill level in the managed hosting space" as well as to "highlight that by having a publicly traded entity."

"It was a cheap way to get control of Digex," said Stephen Murphy, analyst for CIBC World Markets.

Demand in the Internet hosting business is shifting from so-called co-location, where companies like WorldCom and Exodus (EXDS Quote) sell little more than floor space and an Internet connection, to managed hosting, where companies like Digex, Navisite (NAVI Quote) and Data Return (DRTN Quote) manage distribution and maintain systems, Murphy said. He rates Digex shares a buy, Exodus shares a buy and Data Return shares a strong buy. His firm rates Intermedia shares a buy and WorldCom shares a hold and does not cover Navisite. CIBC has done underwriting recently for Digex and for Data Return.

The shift, which Murphy said is partly a result of the scarcity of information technology workers and partly due to the increasingly complicated nature of Web sites, has garnered other offers for Digex.

Exodus had offered to buy Digex for about $8.5 billion in stock, or about $120 a share. Murphy supposed that Exodus may now pay for tipping its hand and losing the bidding. Its shares closed down $3.38, or 5%, to $62.94.

If it still desires a Web hosting unit, Exodus could return to Global Crossing (GBLX Quote). Earlier this summer, Exodus was in talks with Global Crossing to acquire the GlobalCenter unit for about $6.6 billion in stock, the Journal said.

Stupka said WorldCom sees the same shift to managed hosting the analyst noted. "Most companies who need some kind of e-commerce don't really need e-commerce people every day seven by 24," he said. "Initially they thought they would need that."

In 1997, Intermedia bought Tampa, Fla-based Digex for around $150 million.