Rackspace taken private by Apollo; narrative misleading, Rax positioning to win
Summary: Rackspace will be taken private after being acquired by a group of investors headed by Apollo Global Management, LLC in a deal valued at $4.3b. The transaction ends years of chatter and speculation about Rackspace’s future. Rackspace had been positioning for such a strategic move in recent months when it sold assets it would no longer emphasize: the divestitures of Jungle Disk and Cloud Sites.
Context: Rackspace has looked at a number of strategic options (over the last several years) that ultimately were not pursued for various reasons. The private equity path does make sense right now as Rackspace is looking at a unique opportunity. The shift to cloud is on. Meaningful scale has been built in terms of operating efficiency, pricing, technology and innovation. The only place where the clouds are not achieving scale (and not even really pursuing it) is in support, consulting and managed services – areas that are less likely to be automated and addressed with technology. These tasks are by and large being left to the partner ecosystem and of course, service providers. And that is where Rackspace is stepping in. There is no clear leader here and today’s market almost harkens back to the early days of managed hosting where there was a fragmented competitive landscape facing a huge greenfield opportunity. Rackspace wants to win the managed third party cloud (just as it was a big early winner in managed hosting) and it is prepared to undergo a period of transition that will see it divert resources and accept less than optimal short-term results. It will compete in this market with an eye to the long-term. Being a public company – to be fair – would be a burden and monetizing now provides value to shareholders and gives it an ‘umbrella’ to make this pivot.
The narrative: The narrative in the wake of this transaction has been about Rackspace ‘losing’ in the cloud wars. Some have referred to it as a ‘second tier’ player. These are binary takes that overlook a lot of nuance. Firstly, it is hard to think of Rackspace being a ‘loser’ in the cloud wars when it has won over $2b in infrastructure hosting business. Call it managed hosting, call it cloud. Call it whatever you want. Rackspace manages a good chunk of the outsourced infrastructure market and competes very well in the ‘premium services’ use case. Not good or bad (the black and white that the talking heads love). Just different. Sure, Rackspace has showed weaker results over the last few years and it is winning less workloads suited to the big public clouds – not unlike the rest of the market. But it is still growing at healthy rates and it is doing this at a level of scale few in the infrastructure services market have. Rackspace has shown it can milk the model. It wins new customers, it keeps them for long durations with low churn and it is growing its existing base. Revenue growth is still there.
Our take: Rackspace has hit a crossroads to be sure. But it is positioned uniquely to win in this next phase of the market’s evolution. It wouldn’t surprise at all if Rackspace would be able to win the ‘premium managed’ game again – this time though, it will win it on top of third party clouds rather than on its own infrastructure. Why bet on Rackspace? It is ingrained with the right kind of DNA, owns recognizable branding and reputation, and unlike almost twenty years ago when it first began to compete in managed hosting, has an edge in scale, experience and resources to win in this market. That it has taken strategic moves to position itself or this next battle speaks volumes. In terms of building blocks, Rackspace also has the right ‘traditional infrastructure’ portfolio as well as growing on-premise capabilities. In short, it is positioned to address a very wide range of use cases for the multiple workloads and requirements that live in IT departments and are increasingly going to be found in ‘the cloud or clouds’ (in some combination). This will be increasingly crucial in a market where the conversation is less about ‘left and shift’ and more about ‘solve my problem’.
Speculation on our part: How about a combination of Rackspace and Datapipe to take on the managed third party cloud world? Datapipe has a growing reputation in this market and some interesting technology and capabilities. It has moved first but hasn’t pulled away. Rackspace would bring the resources, brand name and Fanatical Support reputation. The primary part of Datapipe’s and Rackspace’s portfolios – still very much bare metal and private cloud – would also match up quite well and could be merged together. What would the end game from here be? We’ve always thought that a big consulting firm already playing in the cloud on-boarding world would make a logical strategic buyer. For example, someone like Accenture that has already acquired firms that on-board SaaS users. Cloud infrastructure and managed services would be a logical next step as more workloads in IT departments move to cloud.
Transactions details: Rackspace will be acquired for $32.00 a share and this represents a 38% premium on the August 3, 2016 closing price of $23.16. The transaction is expected to close in 4Q16.
Operational details: Rackspace will continue to be HQ’d in San Antonio and the branding of the company will not change. Taylor Rhodes will stay on as president and CEO.
Advisors: Financing and financial advisory was provided by: Citigroup, Deutsche Bank, Barclays and Royal Bank of Canada. PSP Investments Credit USA LLC also participated in the financing. Goldman, Sachs & Co. was financial advisor to Rackspace.
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