Rackspace (RAX) CEO Taylor Rhodes would not address reports of sale talks with private equity firms during a second quarter earnings call. Even though the cloud services provider topped expectations for the period, markets focused on the the impact of Brexit and reduced sales from divested businesses on the second half of the year.
The company earned 28 cents per share, or 38 cents per share excluding items such as stock-based compensation, beating forecasts of 22 cents per share. Revenues of $524 million topped forecasts of $521.1 million and Backspace notched a record $98 million in free cash flow for the period.
Shares of Rackspace dropped 41 cents per share, or 1.4%, to $28.20 after hours on Monday. The stock fell 2.25% during Monday's trading session.
Chief Financial Officer Karl Pichler said that currency fluctuations and divested assets would reduce sales by $70 million. Brexit will take a $50 million bite, Pichler said.
Rackspace forecasts full year sales of $2.06 billion to $2.08 billion, versus expectations of $2.11 billion.
Brexit profits are hedged, management explained, because costs are also in pounds and would drop in synch with reduced sales.
Rackspace is divesting its Cloud Sites web hosting business to Liquid Web for an undisclosed sum, with the deal closing in the third quarter. In the first quarter, Rackspace sold its Jungle Disk data security unit to venture capital investors.
"Philosophy wise, we have been looking at the business and finding businesses that are growing at a lower rate than the core," Rhodes explained. The operations would require "substantial investments" if kept.
Philosophy lessons aside, investors want details on reported talks with private equity suitors. The Wall Street Journal reported talks of a $3.5 billion takeout, which comes to about $27 per share. Analysts suggested that $32 per share could be a more agreeable sale price.
"We believe that ($27 per share) is low and that a deal in the $32 area is more likely," Oppenheimer analyst Timothy Horan wrote in a report on Sunday. Shares traded close to $32 last week when reports of sales talks appeared.
Among other steps, a private equity backer could cut operating expenses by 20% and boost leverage to 4 times Ebitda, Horan observed. At $32 per share, Rackspace's valuation would come to $4.3 billion including debt. The analyst suggested that private equity could get away with just a $1.3 billion equity check, or about 30% of the total valuation.
Should another tech company emerge as a bidder, Horan suggested the price could reach the upper $30s. However, insiders might be tempted by a lower offer if they could take equity in the company.
Rhodes took over as Rackspace CEO in 2014, and has been trying to turn around the cloud services company. Cloud computing services from Amazon (AMZN) - Get Amazon.com, Inc. Report , Microsoft (MSFT) - Get Microsoft Corporation (MSFT) Report and Alphabet's (GOOGL) - Get Alphabet Inc. Class A Report Google are reshaping the cloud sector. During Monday's call, Rhodes touted the growing partnerships with Amazon and Microsoft, explaining that many clients want a service provider to manage their cloud dealings with the large cloud providers alongside other IT needs.
Gray Powell of Wells Fargo also modeled a $32-per-share takeout of Rackspace. If the private equity buyers paid 30% of the total in equity, he suggested, they could cover the rest with debt equaling 4 times Ebitda. The deal would put the sponsors in line to collected a 25% annual return over three years, he suggested, if they could sell for $5.3 billion in 2019.
Powell's exit expectations are lower than Horan's, though, who suggested that the PE owners could sell for 8 times projected 2021 Ebitda, which would come to about an $8 billion in total.
But private equity might have to pony up more equity to make a deal work, Barclays analyst Amir Rozwadowski suggested in a report.
Based on a $4.2 billion sale price, including debt, Rozwadowski wrote that PE suitors could raise 2.8 to 3.1 times 2016 projected Ebitda, or $2 billion to $2.2 billion, in debt.
"Thus to make a deal work," he wrote, "private equity sponsors would need to contribute [$2 to $2.2 billion] of equity."
In the absence of a sale or news about negotiations, Rackspace's forecasts couldn't support the stocks recent gains.