Shares of Rackspace Hosting (RAX) plunged 17% in after-hours trade yesterday after the company ended its search for a prospective buyer.
Rackspace’s search for possible acquirers was helped by Morgan Stanley (MS). During the evaluation process, names such as Hewlett-Packard (HPQ) and International Business Machines Corporation (IBM) and very recently CenturyLink Inc. were rumored to be interested in the company. Nonetheless, nothing concrete came out of the reported buyout offers.
Thus, failing to find a satisfactory suitor, Rackspace is set to chalk out a plan to operate independently. The company has also named a new CEO, Taylor Rhodes, who spearheaded its managed cloud services business.
Rackspace’s board considered the buyout option to counter the intense competition in the Infrastructure-as-a-Service (IaaS) market, particularly from players like Amazon that were not averse to very aggressive pricing and behemoths like Microsoft and Google that were determined to build a position in the fast-growing segment.
Thus, in order to compete effectively, the company also priced its offerings competitively which, in turn, hurt its margins.
During the last reported quarter (second quarter of 2014), despite a 17.4% year-over-year top-line growth, Rackspace’s margins were down significantly due to higher costs, professional fees and software license expenses. Gross margins contracted 158 basis points year over year, while operating margins came in at 7.7% compared with 9.4% in the year-ago period.
Despite these numbers, Rackspace’s focus on a hybrid cloud computing environment makes it an attractive acquisition target, in our view. Hybrid clouds comprise features of both public and private clouds and are much more secure than public ones.
Also, the company witnessed new customer wins and continued business from its existing customer base. Moreover, the company provided an encouraging revenue outlook.
Per Technavio, the global hybrid cloud market is forecast to grow at a compound annual growth rate of 30.2% during 2013-2018. According to Gartner, 50% of mainstream enterprises will adopt hybrid clouds by 2017-end.
Nonetheless, the current situation is a bit of a downer for shareholders as they were rooting for the company’s possible acquisition to gain from their share holdings. However, the company has suggested a possible repurchase program to be initiated in the near term to enhance shareholder value.
Currently, Rackspace has a Zacks Rank #3 (Hold).
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