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Is Rackspace Looking For A Privatization Escape Route?

This article is more than 9 years old.

The rumor mill was driven into high gear back in May when it was revealed that hosting and cloud infrastructure vendor Rackspace (disclosure, Rackspace sponsored a vendor neutral cloud education program I developed a couple of years ago) had engaged Morgan Stanley to look at “strategic options” for its future. Most commentators saw this as the Rackspace board looking for a buyer for the business. And the reasons for this seem obvious, previously widely seen as the number two cloud infrastructure payer, their relative position against industry heavyweight Amazon Web Services (AWS) has gotten significantly poorer over time. At the same time other competitors have come to market with some compelling propositions, both existing vendors ( Google , Microsoft and IBM SoftLayer for example) and new upstarts (DigitalOcean being the best known example). So finding a suitor in the face of difficult times is a natural, if difficult, option.

An article on TechCrunch today adds an interesting twist to that story. Citing a “well placed” but unverified source, TechCrunch suggests that Rackspace is in fact talking with private equity firms in order to borrow capital to fund a privatization of the company, potentially as soon as this week. Quoting the unnamed source, TechCrunch wrote that:

The pressures of being a public company are too much [for Rackspace]

According to the article, Rackspace has actually had three separate acquisition offers, including one each from HP and IBM . Detailing some highly informed information, TechCrunch writes that the HP offer was for up to $43 per share, a significant premium over the current price of $33.66. At this level the offer would have valued the company at over $6.1B, as opposed to the market capitalization currently of just under $4.8B. As for the IBM offer, it apparently fell through, again neither party is commenting on the acquisition claim however chief of IBM SoftLayer, Lance Crosby, has gone on record saying that an IBM acquisition of Rackspace would be “not exciting”.

So in the absence of a sufficiently compelling acquisition offer, TechCrunch’s source suggests that a private equity deal is starting to look attractive. In going down this route, Rackspace would be following in the footsteps of fellow technology vendors (and, coincidentally, Texas-based companies) Dell and BMC. Both of these vendors went private over the past year.

But the reasoning for both Dell and BMC to go private had more about their need to innovate and change the direction of their businesses than any other reason. Both companies had significant businesses that, while highly successful in times gone by, had lost some of their luster as the cloud started to take hold. Both BMC and Dell believed that having the freedom to execute away from the extra oversight that being a public company brings would be beneficial to their future opportunities.

Rackspace, on the other hand, is in a different situation. Their dismal stock market performance to date (and, it must be said, their poor relative performance in industry analysts' reports of late) has more to do with the fact that they’re a small player trying to compete with industry heavyweights. Rackspace has been taxed by the fact that AWS, Google, Microsoft and IBM SoftLayer can out-invest it in terms of capacity build out. In an industry where prices are dropping while capital investment is ramping up – being a relative minnow is a huge barrier. Being private wont change this fact.

Rackspace is in an unenviable position, they’re being out-innovated and out-performed by their larger competitors, and in my view the reasons for that have nothing to do with Rackspace’s capital structure. While privatization would give current shareholders an attractive escape route, it won’t be likely to do much for the company itself.

TechCrunch’s source indicated that an announcement could come this week but in a follow up research note, Dealreporter has poured cold water on Rackspace’s ability to actually take itself private. Time will tell but it would seem that Rackspace’s board is sitting in an uncomfortable position between a rock and a hard place.

 

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