TMT Blog: Why does nobody want Rackspace?

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Back in May when Rackspace hoisted a (very) thinly veiled For Sale sign over its head with the hiring of Morgan Stanley to explore the “multiple parties who have expressed an interest in a strategic relationship with Rackspace” a sale looked a highly likely prospect.  Rackspace, a $1.5bn player in the ever popular cloud infrastructure/managed hosting space was thought to have an extensive list of possible trade buyers as well as Private Equity interest.

Fast forward to September and the business announces “its commitment to remain independent” – otherwise known as “we haven’t found ourselves a decent buyer” – with shares quickly falling 17% as a result.  So what went wrong?

To start with that extensive list of trade buyers didn’t prove to be quite as extensive as first thought if reports are to be believed.  CenturyLink, a US telco seemed the most likely buyer but may have baulked at price, others like HP proved busy with other (more interesting) deals (Eucalyptus) whilst the price tag would have been out of reach for those players below the first tier of providers.

And there’s (part of) the rub for Rackspace, a $1.5bn underdog in a game of giants.  Too large to appeal as a niche techy buy for a major player or a scale play for a mid-tier competitor and too small to effectively compete with them on a standalone basis.  Thus growth has slowed over the last year or two (albeit still double digit) and margins have been squeezed as the likes of Amazon Web Services (AWS) continually cuts prices leaving Rackspace to follow suit as well as to spend increasing amounts on R&D and sales and marketing in order to somehow differentiate its offering.  Although the business is currently trading at 7.4x 2014 EBITDA one suspects that this is a long way below the figure they hoped to be attracting with the original For Sale announcement.

And so, barring a knight in shining dollars, it looks like it could be a long road ahead.  In an increasingly price competitive environment you must either:

a)     Be huge

b)     Have a clear USP for customers as well as for potential suitors – i.e. don’t compete with AWS; or

c)     Correct your value expectations

Suspect option B will prove the most appealing.