We’ve been pursuing investment opportunities in the data center space since the sale of Inflow in 2005. Most recently, since the formation of Fund III, we’ve been proactively searching for an entry point into the segment. Valuations in the space have exceeded our sensibilities keeping us on the sidelines. Through the formation of Digital Fortress we’ve created a unique and compelling entry-point into the segment.

Our evaluation of the Seattle market dates back to October 2010, culminating with Meritage signing letters of intent to acquire digital.forest, Inc. and the assets of Fortress Colocation Services during June 2011. We launch Digital Fortress with the simultaneous completion of these two acquisitions and the announcement of plans to refurbish an existing enterprise data center space in downtown Seattle. The operations of the two initial acquisition targets are located in the same building on Sabey Corporation’s Intergate.West data center campus located ten miles south of Seattle, WA. Both targets serve large and mid-sized enterprise customers with traditional colocation services, and differentiate their offerings by delivering high-density power capabilities. Under Mark Hughes leadership, the operations of these facilities are being combined under the umbrella of a single operating model, preserving and enhancing the value proposition in the process.

The Company will simultaneously expand its operating footprint through the refurbishment of an existing enterprise data center in downtown Seattle. The new facility will offer 18,000 square feet of data center colocation space. In total, the Company will operate in excess of 40,000 usable square feet of data center.

The colocation market remains a regional business. Seattle and the Pacific Northwest are considered by industry experts like Tier1 Research to be amongst the most attractive markets for data center operators in North America. Seattle, in particular, is blessed. Data center supply in metropolitan Seattle is already constrained. And because the future rate of demand growth is expected to exceed the rate of supply growth, available capacity will continue to be in short supply. In addition, Seattle has some natural advantages over other metropolitan markets, including a cool climate and access to low-cost power. More than 90% of the power used by Digital Fortress’ facilities is generated from renewable sources, principally hydroelectric generation.

Meritage led the structuring and equity syndication of this investment, resulting in equity commitments from Halyard Capital and Sweetwater Capital, both of whom we’ve invested with previously. Halyard Capital was a co-investor in Inflow Communications and Sweetwater Capital, led by Bill Marraccini, was a co-investor in our already successfully liquidated Fund III portfolio company NewPath Networks.

We’re excited to have led this transaction and about Digital Fortress’ prospects. David Solomon and Derek Pilling will represent Meritage on the Company’s Board of Directors. We look forward to working with Mark Hughes, the management team, and our co-investors to make Digital Fortress a success.

The company addressed both sides of its growth goals in 2011, expanding into the Florida telecom market with the acquisition of Peoples Choice Cable in Boca Raton while also setting company records for organic sales. AM3’s dramatic growth landed it on the 2011 Inc. 500 list of the fastest growing companies in the U.S.

AM3 supplies triple-play (TV/internet/voice) services to multi-dwelling unit properties in Florida, Georgia, Illinois, Minnesota, Tennessee, Virginia, and Washington D.C. The Company serves more than 50,000 subscribers in more than 500 properties.

We’ve worked with Intel in a number of other investments, including our co-investment at Crisp Media, and introduced them to IPC several months ago. They, like us, were immediately intrigued by IP Commerce’s platform as a service (“PAAS”) approach to electronic payments. Ultimately, Intel concluded that the Company is the clear leader in its space and that the Company’s approach to integrating value added services into the payment process stream is unique and incredibly valuable to payment application developers.

I’m personally excited to be working with Intel here as we’ve developed a valuable repeat relationship with them. In particular, I’m pleased to once again be working with Bavanipratap Rana, my colleague from Intel at Crisp Media, and Vibhor Rastogi, who together will represent Intel on this investment. Rana and Vibhor have a keen understanding of the Company’s opportunity and will work hard to bring the full resources of Intel along to support the Company’s efforts. Welcome to the team and congratulations to IP Commerce on completing this important financing.

Meritage Funds is pleased to announce that David L. Solomon has been appointed as a Managing Director of the firm. Mr. Solomon was a co-founder of Meritage and has served as an Operating Partner of the firm since its inception. Mr. Solomon has 16 years of operating and entrepreneurial experience and 13 years of public accounting experience.

“David’s proven entrepreneurial, management and investment judgment will be key to the Firm’s ongoing success.” stated Jack Tankersley, Founder and Managing Director of Meritage Funds. “With David’s decision to assume a leadership role, the Firm’s long-term future is bright.”

Mr. Solomon currently serves as Chairman of the Board of Meritage portfolio company IP Commerce and served as director of Meritage portfolio company Diveo Broadband Networks until its sale in December 2010. Mr. Solomon served as CEO and later Executive Chairman of Meritage portfolio company NuVox Communications from November 1999 until its $643 million acquisition by Windstream Corporation in November 2009. Under Mr. Solomon’s leadership, NuVox grew its annual revenues from less than $200,000 to over $530 million. Prior to NuVox, Mr. Solomon served as CFO of Brooks Fiber Properties (acquired by WorldCom for $3.4 billion) and as a Partner with KPMG.

For more information about this transaction, read Masergy’s press release here.

Over the past year, Crisp has established itself as the leading mobile rich media vendor in North America. The Company has struck strategic relationships with nearly every major online publisher in North America, including Yahoo!, CNN, The Weather Channel, ESPN, The Wall Street Journal, MSN (Microsoft). In addition, the Company has established a strong reputation within the agency and advertiser communities for its ability to deliver large mobile rich media buys, that are served from a single technology platform reaching smartphones, tablets and other connected devices. The Company’s outstanding campaign execution has resulted in repeat advertising buys from some of the largest brands in the world including Toyota, Ford, Sprint and others.

Many of Crisp’s customers (both publishers and agencies) market globally. To date, Crisp has executed a number of global campaigns, serving these campaigns from the Company’s North American operations. With increasing global demand for Crisp’s platform, particularly in APAC, the Company embarked on a plan to establish operations in the APAC region, culminating in EDBI’s strategic investment. EDBI’s investment will not only provide Crisp with the capital to facilitate this expansion, but will also offer the Company critical contacts in the APAC region, accelerating the Company’s market entry.

We welcome EDBI in joining Meritage and Intel Capital in Crisp’s investment syndicate and look forward to working with both EDBI and management to establish Crisp as the leading global mobile rich media platform.

Separately, the Internet Advertising Bureau (”IAB”) mobile working group has decided that its work to standardize how rich media advertising is integrated into mobile application environments will be based on ORMMA.  ORMMA (open rich media mobile advertising) is an open standards initiative of which Crisp Media is a founding member.  Xavier Facon, Crisp’s CTO, has been instrumental in launching ORMMA and establishing this vendor-agnostic approach to delivering in-app rich media ads as an industry standard in very short order.  This emerging standard will serve all participants in the mobile ecosystem well, including publishers, advertisers, and rich media vendors like Crisp.  Kudos to the ORMMA members for doing something that is good for everyone in the industry.

In the case of Diveo and NuVox, our exit was frankly overdue as our Fund I made its initial investments in these companies in 1999. In an ideal world, these companies would have been sold as early as 2007 and certainly by 2008, as both were strongly EBITDA positive with excellent growth. As we all know well, strategic buyers had limited appetite for acquisitions in the 2008-09 timeframe, and the timing of our 2010 exits was due in large part to the return of strategic buyers with pent-up demand to the marketplace.

Both NuVox and Diveo were formed in frothy markets where debt and equity funding was readily available for capital-intensive projects, and both companies had large, unwieldy investment syndicates. As these companies started to mature, they encountered perhaps the most difficult markets (both financial and operational) in the history of the communications industry. While many larger and better-known enterprises failed in this market, NuVox and Diveo survived by virtue of significant restructurings and excellent leadership. In the case of NuVox, Meritage partner David Solomon was the Chief Executive Officer and led the company not only through a significant restructuring, but also through two major acquisitions. Under David’s stewardship, NuVox grew from a few hundred thousand dollars in revenue in 1999 to well over $500 million in revenue at the time of its sale. Interestingly, there were investors in NuVox who chose not to participate in the restructuring, and therefore did not benefit from David’s work. In the case of Diveo, Bob Goad stepped in and provided the operational and strategic leadership necessary to build the company into a strongly EBITDA-positive entity following its restructuring.

NuVox was purchased by Windstream Communications in February for approximately $650 million, and Diveo was purchased by Universo Online in December for approximately $475 million. We at Meritage take great pleasure in having been part of building these two significant enterprises. Both companies were started in the best of times, and both weathering the worst of times. NuVox and Diveo are now in the hands of significantly larger enterprises where they will be important earnings contributors going forward.

The third company we sold in 2010 was NewPath Networks, a Fund III portfolio company. NewPath was an altogether different story, as the sale of this company occurred only 16 months from the date of our original investment. We invested in NewPath alongside Charterhouse Group in April of 2009, believing that the company’s distributed antenna system (“DAS”) networks represented the next generation in communications tower infrastructure for high-density markets. We also believed that NewPath’s management team, led by Mike Kavanagh, was the best management team in the sector. NewPath was the smallest of the three “pure play” DAS operators by size but had achieved strong market positioning as a result of its strategy of building systems with high lease-up potential.

When we participated in the company’s $30 million institutional financing, we believed NewPath had adequate capital to build a significant footprint and make needed operational gains. Shortly after the closing, however, the industry landscape changed dramatically. First, our largest competitor was purchased by a large private equity firm, which made available significant additional capital (rumored to be $150 million) to this competitor. Our second largest competitor responded by raising $128 million in a significant equity financing. All of a sudden, NewPath’s $30 million looked quite modest! We quickly initiated a financing effort to raise at least $75 million, despite our concerns about dilution. Soon after hiring an investment banker, NewPath was contacted by both of its pure-play DAS competitors as well as several major tower operators, all seeking to purchase NewPath rather than have us raise additional capital. The company’s pure-play DAS competitors had the most to gain from an acquisition but proved to be “flat footed” in the process, thus setting the stage for the ultimate acquirer, Crown Castle, to become the dominant force in the sector.

Crown Castle purchased NewPath in September 2010 in a transaction that valued the company at approximately $115 million. By combining its communications towers and capital with NewPath’s DAS capabilities and know-how, Crown is now extremely well positioned. Although we would have liked to have grown NewPath into a much larger company, we realized that given the limited resources of the NewPath investors and the enormous dilution that was in store if we proceeded to raise more capital, we were ultimately on a precarious path. Therefore, from a portfolio management perspective, this was an excellent transaction.

Our success in 2010 demonstrates that the strategic buyer is alive and well for services companies. Buyers are seeking scale and/or seeking to fill specific strategic needs. This means that there continues to be an enormous role for private equity investors to grow their portfolio companies both organically and inorganically to take advantage of the current appetite of strategic buyers. Of course, the downside of an improving market is the impact on pricing of new investments. As we have learned on more than one occasion during the past ten years, private equity investors must be disciplined from a valuation perspective in order to generate attractive returns.

In a recent conversation with one of our limited partners, we learned that their 2010 distributions exceeded their internal forecast by 2.5 times, illustrating that our strong 2010 liquidations was an industry-wide occurrence. While the volume of activity will likely not match the 2010 level, we at Meritage believe that 2011 will continue to offer a robust environment to sell strong, profitable and growing companies.

“Ryan has been with us seven years, and has proven to be very effective in working with our portfolio companies and very diligent in the sourcing arena.” stated Jack Tankersley, Co-Founder of Meritage Funds. Meritage Co-Founder David Solomon noted that “Meritage prides itself in bringing the combination of both proven operating skills and investment talent together to best serve our portfolio companies. Ryan’s experience here at Meritage, along with his prior experience as an early employee who helped start a major financial services firm, allows us to build on a tradition of investment professionals with a combination of both skill sets.”

Prior to joining Meritage in 2004, Mr. Pollock worked for Investec Asset Management, a $70 billion global investment management company based in London. Mr. Pollock holds an undergraduate degree from the University of Cape Town, a graduate degree in International Economics, Politics and Philosophy from Oxford University and an MBA from the University of Texas at Austin, where he graduated as a Venture Fellow. He currently serves as a director of Miniweb Technologies and Perlego Systems, both Meritage portfolio companies. Mr. Pollock is a member of the board of directors of the Rocky Mountain Venture Capital Association, a venture advisor to the Founders Club in London, an executive coach to MBA students at The Daniels College of Business at Denver University, and the founder and Chairman of Starfish Greathearts Foundation USA.

We are grateful for that flexibility, because it has enabled us to construct diversified portfolios targeted at the investment stage(s) where we see the best risk/return ratio. That said, we are constantly refining our stage orientation to ensure proper alignment with current and long-range market conditions, the objectives of our Limited Partners and the skills, interests and intellectual assets of our firm.

Recently, we have narrowed our stage orientation to focus exclusively on Growth Equity opportunities. We believe that Growth Equity investment is an investment style unto its own, separate and distinct from venture capital and leveraged buyout investments as traditionally defined.

So what is Growth Equity? Definitions abound, but in our view Growth Equity investments should exhibit the following characteristics:

Proven Value Proposition and Economic Model

Candidates for Growth Equity investment typically operate in a quantifiably large market with a proven value proposition and economic model. These businesses know how to sell their product/service and how to identify their target customer and understand the economics of customer acquisition. With this foundation in place, growth-stage businesses can deploy investment capital at the use(s) of proceeds that generate the highest return on investment.

This cannot always be said of venture investments, which often wander in the woods and must “pivot” before discovering a market, or leveraged buyouts, which must focus on repayment of debt to create equity value.

Attractive Risk-Adjusted Upside Potential

Growth and value are concepts that are inextricably linked in the financial markets. It is a well-known axiom that the faster a company is growing, the higher the multiple it commands, and vice versa. It is obvious but worth emphasizing that growth-stage businesses create incremental value by growing revenue and profitability. Growth potential is unbounded (except by market size and competitive dynamics) and so Growth Equity investment return potential is unbounded as well.

The same can be said of venture investments, although exit value is often tied more to “strategic value” (which can be fleeting) than financial value. While it is easy to recall high-profile acquisitions of venture-backed companies with unproven economic models, these exits are very much the exception to the rule. Growth Equity returns are more predictable because base exit value is tied explicitly to growth and financial performance, with the added upside potential of strategic value. Buyouts on the other hand often create value through cost-cutting and by reducing debt. As a result, traditional buyout returns are often bounded, as there is only so much cost cutting and debt repayment available to a given company.

Limited Risk of Capital Loss

We make Growth Equity investments in companies that have created a baseline of value and are typically unlevered, so that the preferred equity is not subordinate to debt. If the investment is priced right, the investment need only maintain its value in order to return capital to preferred shareholders.

This is distinct from both the venture capital asset class and the buyout asset class. In buyouts, the equity is typically subordinate to debt, creating a default risk that could wipe out equity. One need look no further than this past business cycle to see how leverage cuts both ways. In venture, the company must typically grow into its valuation by hitting development and/or performance milestones, which if not achieved can render the equity worthless. Venture is about harnessing home-run potential, but with that upside comes higher loss ratios.

We think Growth Equity will offer investors the best risk/return ratio over the coming decade and likely beyond. Does this mean that we think the venture capital and buyout asset classes are doomed? No, quite the contrary, we think that some firms will thrive in both of those categories, although many will also fail. The same can be said of Growth Equity. We are committed to making Meritage a leader in the growth equity segment of the private capital markets. We think we are well suited to accomplish that goal.