Technology

Did Rackspace Shareholders Get Enough From the Apollo Buyout?

Paul Ausick

Published: August 26, 2016 10:40 am

Last Updated: January 13, 2020 4:13 am

Rackspace Hosting Inc. (NYSE: RAX) said Friday morning that it has agreed to be acquired for $32 a share in cash by affiliates of private equity firm Apollo Global Management LLC (NYSE: APO). Including the assumption of $43 million in net cash, the transaction’s total value is $4.3 billion.

Rumors of a Rackspace acquisition surfaced earlier this month and shares gained more than 10% on the day the news broke and nearly as much the following day after hitting an intraday high of over $30. The announced acquisition price represents a premium of 38% to Rackspace’s $23.16 closing price on August 3.

Based on the most recent closing price of $30.19, Rackspace shareholders are getting a bump of 6%. Is that enough? The 12-month consensus price target on the stock was $28.80, ranging from a low of $18 to a high of $44. That high target came from JMP Securities, when it lowered its price target from $55 in February. Several analyst firms raised their price targets following the early August reports that Rackspace was nearing a sale to a private equity company.

Since posting an all-time high around $78 a share in early 2013, Rackspace shares had descended to a low of around $15 early this year. Where the company once had a strong position in the cloud storage space, there was essentially no significant barrier to new entrants and the far deeper pockets and reach of giants like Amazon.com Inc. (NASDAQ: AMZN), Microsoft Corp. (NASDAQ: MSFT), International Business Machines Corp. (NYSE: IBM) and Apple Inc. (NASDAQ: AAPL), and competitive pressure from smaller firms like Dropbox and Pure Storage Inc. (NYSE: PSTG) have changed the playing field.

What we’re likely seeing here is a race to the bottom on pricing. Being in such a race with the likes of Amazon, with its focus on growth as opposed to profits, or Apple, with the deepest pockets in the known universe, is a near-guaranteed loser. Rackspace had $43 million in cash Friday morning, about what Apple would spend if it bought each of its 110,000 employees an iPad.

In that case, did Apollo overpay? Rackspace’s clients for its cloud management services include both Amazon and Microsoft. That neither was interested in buying Rackspace could mean that neither sees the company’s business as a core piece of its own strategy and is happy to farm the job out to a third party. Or it could mean that one or the other (or some other company) is waiting for Rackspace to develop the next big thing in cloud management, at which point Apollo sells to the highest bidder in two or three years for a tidy profit. Our bet would be on the latter, but private equity firms have been known to make a wrong decision before.

The transaction is expected to close in the fourth quarter, subject to regulatory approvals, customary closing conditions and approval from Rackspace shareholders.

Rackspace stock traded up more than 4% Friday morning, at $31.47 in a 52-week range of $15.05 to $32.14.