Rackspace Plunges After Deciding to Stay Independent: What Wall Street's Saying

NEW YORK (TheStreet) –– Rackspace (RAX) shares plunged after the cloud computing company announced it ended its formal review process and would remain independent, removing speculation the company would be sold.

San Antonio-based Rackspace had previously disclosed it was in discussions with multiple parties who had "expressed interest in exploring a strategic relationship, ranging from partnership to acquisition," but ultimately after conductingi ts due diligence Rackspace's board decided to end the acquisition talks.

"We ran a thorough process under the direction of our board of directors, independent advisors, and a Strategic Transaction Committee of the Board," said Rackspace's co-founder and chairman Graham Weston said in a statement.  "In this process we talked to a diverse group of interested parties and entertained different proposals. None of these proposals were deemed to have as much value as the expected value of our standalone plan. We concluded that the company is best positioned to drive value for shareholders, customers and Rackers through the continued execution of its strategic plan to capitalize on the growing market opportunity for managed cloud services."

Shares of Rackspace were plunging in early Wednesday trading, falling 17.3% to $32.55.

The company also announced that it had considered buying back stock, but determined that it was not prudent to buy back its own stock to make "the appropriate investments" to keep the company's strategy on track.

Rackspace also announced that Weston, who had been Rackspace's CEO since February, would become non-executive chairman, and would be replaced by Taylor Rhodes, effective immediately. Rhodes, who had been Rackspace's president, would also become a member of the board.

Following the announcement, analysts were cautiously positive on the company's future prospects, despite the lack of a strategic buyer. Here's what a few of them had to say:

Credit Suisse analyst Sitikantha Panigrahi (Outperform, $40 PT)

"While we had expected Rackspace to end its strategic evaluation process without being acquired (see our report, Rackspace Solve Takeaways on July 29, 2014), the announcement not to pursue a share repurchase program was a bit of a disappointment to investors. However, we believe that the company might reconsider the share repurchase program in the future given the involvement of activist investors. Furthermore, we have confidence in Taylor Rhodes' leadership and execution, which has been reflected in the last two quarters' results. Additionally, we expect the company to focus on margin expansion. Moreover, the company has changed its strategy to focus on the managed cloud opportunity, and we believe that Rackspace is well positioned to benefit from secular growth trends in cloud and that the company can carve out a niche with its differentiated cloud offerings based on performance, 'fanatical support,' and its OpenStack-based open cloud."

Canaccord Genuity analyst Greg Miller (Hold, $35 PT)

"After the close Tuesday night, Rackspace Hosting announced that it would promote its current president, Taylor Rhodes, to the CEO position and that it was ending its lengthy evaluation of possible M&A transactions and/or strategic partnerships. Importantly, the company also decided against the implementation of a meaningful share repurchase program that could have provided some support for the stock. Although we expect the stock will come under significant pressure with the clearly disappointing news, we do not believe this represents a catalyst for a continued downward slide in the stock. We believe this team can re-tighten sales cycles and return the company to its previous trajectory."

Jefferies analyst Mike McCormack (Hold, $35 PT)

"Late Tuesday, Rackspace announced the end of its strategic review process, with the company concluding that its outlook as an independent company outweighed assessed strategic alternatives. The conclusion is not surprising as we believe there was a wide disconnect between potential offers and the company's view of long term value. Shares of RAX should return to trading on fundamentals rather than M&A, with revenue growth the key metric to monitor."

JMP Securities analyst Patrick Walravens (Market Outperform, $67 PT)

"We maintain our Market Outperform rating and $67 price target on Rackspace after the company announced that it had ended its formal evaluation of the M&A transactions that it first disclosed on May 15 -- leading the stock to drop 17% in the aftermarket as investors hoping for an acquisition registered their disappointment. Rackspace also announced Taylor Rhodes as CEO, indicated it would not authorize an additional stock buyback program at this time, and reiterated its guidance for Q3. While the volatility in the stock caused by the M&A offers and rejection has been unfortunate and difficult for both investors and management, we continue to like the fundamental story at Rackspace because: 1) we believe the company is effectively differentiating its managed cloud solutions from unmanaged offerings from Amazon Web Services, Google, and Microsoft; 2) we expect revenue growth to accelerate; 3) we expect margins to increase; and 4) our initial sense is that Mr. Rhodes is likely to be an effective leader for the company. We look for 2014E non-GAAP EPS of $0.68 (consensus $0.68), and 2015E non-GAAP EPS of $0.87 (consensus $0.88). At its after-hours price, Rackspace trades at a 2015E EV/revenue multiple of 2.0x, and a 2015E EV/EBITDA multiple of 6x; while our $67 price target implies an EV/revenue multiple of 4.4x, and a 2015E EV/adjusted EBITDA multiple of 13x."

--Written by Chris Ciaccia in New York

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