Investors Jump from Rackspace as Review Ends With No Deal

NEW YORK (The Deal) -- Shareholders of Rackspace Hosting (RAX)  received two disappointing pieces of news after the close on Tuesday. Not only will Rackspace terminate its review without a sale, the company also will not buy back shares as an alternative.

New CEO Taylor Rhodes said Rackspace could even be a buyer.

The cloud vendor's stock plummeted $6.29, or 16%, to $33.05 on Wednesday morning, as investors who had purchased Rackspace in anticipation of a sale dumped their positions.

"From our perspective, the real disappointment in the release was the lack of a share buyback, which we admittedly thought would be a potential catalyst for the stock," Gray Powell of Wells Fargo Securities  (WFC) wrote in a Wednesday note.

Rackspace could repurchase $900 million in shares while keeping its leverage below a single multiple of Ebitda, Powell suggested.

Activists already hold the stock, with Blue Harbour Group disclosing a position in August. Rackspace could face shareholder pressure to return cash to investors. Asked why the company did not buy back shares when it trades at 6.5 times Ebitda, Rhodes said it was "improper for a growth company ... to take on debt to buy back shares."

The company will hold onto its cash to "preserve our financial flexibility," Rhodes said, adding that Rackspace could make acquisitions to speed its growth.


Rackspace disclosed in May that it had hired Morgan Stanley  (MS) and Wilson Sonsini Goodrich & Rosati to explore options, after receiving overtures from unnamed entities.

"When there are multiple parties involved these things take time," Rhodes said regarding the length of its review. The board decided Rackspace was worth more as a standalone company, said Rhodes and chairman Graham Weston.

The San Antonio-based hosting company said that its business had begun to turn around, and that second-quarter growth of 4.3% was the highest since the fourth quarter of 2012.

Evercore Partners  (EVR) analyst Jonathan Schildkraut suggested that the M&A story may not be over for Rackspace.

"In just the last few years, we have seen a number of companies in the telecom space come [sic] consider [a] sale, not find a favorable market, [and] return to the core business - only to be sold 12-18 months later," he wrote in a Wednesday report.

Network operator TW Telecom tested the market last year and announced a $7.3 billion sale to Level 3 Communications (LVLT)  in June. Schildkraut also cited AboveNet, which sold to Zayo Group for $2.2 billion in 2012.

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