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Rackspace to Go Private?

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Shares of Rackspace Hosting, Inc. surged 6.3% after TechCrunch reported that it was likely to go private. In May, Rackspace hired Morgan Stanley (MS - Free Report) to evaluate its strategic options.

Reportedly, at least three companies, including Hewlett-Packard (HPQ - Free Report) and International Business Machines Corporation (IBM - Free Report) have expressed their interest in acquiring the cloud computing company. Hewlett-Packard offered $43.0 for each Rackspace share, at a premium of approximately 20.0% over its Jul 2 closing share price. The talks with IBM have apparently fallen through and not much is known of the third suitor.

Rackspace leases server space and helps enterprises store and access data in the cloud. In fiscal 2013, the company reported net revenue of $1.5 billion and served 200K customers (mainly SMB), managing more than 103K servers. It has a strong balance sheet with net cash of $313.8 million as of Mar 31, 2014.

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 clouds.

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, 50.0% of mainstream enterprises will adopt hybrid clouds by the end of 2017.

However, competition in the Infrastructure-as-a-Service (IaaS) market is intense, particularly with players like Amazon that are willing to price very aggressively and behemoths like Microsoft and Google, which are determined to build a position in the fast-growing segment. The increasing competition has impacted the company’s profitability. In 2013, Rackspace reported earnings of 61 cents per share, which declined 18.7% from 2012.

While we think that there are pros and cons to both the takeover and going-private options, investors are clearly rooting for the latter.

Currently, Rackspace has a Zacks Rank # 2 (Buy).

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