Rackspace Hosting: Worth a look at current price

Ann C. Logue | Aug 12, 2008 6:09am EDT | Comment

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Rackspace Hosting
Priced Aug. 7
$187.5 million proceeds
$1,614.1 million post-money valuation

Rackspace Hosting, Inc. (NYSE:RAX), which has been in business since 1998, operates six data centers in the United States and two in the United Kingdom. Each is a warehouse filled with servers that host websites, hold application software, and store data. Rackspace also provides redundant systems, high security, and 24-hour support in order to ensure that customer’s websites and IT networks stay up and running. Some customers own their servers and handle the maintenance themselves; others lease servers from Rackspace and use their technicians for support. Either way, the company brought in $362.0 million in revenue in 2007, an increase of 61.64% from 2006. Some of that was due to acquisition, though.

The company is profitable, although profit growth is less steady than revenue growth. In 2007, the company posted net income of $17.8 million, down from the $19.8 million recorded in 2006. Rackspace broke even in 2003 and has been profitable ever since. One factor in projecting profitability is that the business is capital intensive. It requires ongoing investments in technology and infrastructure. Even though the company leases its data centers, it still has to do extensive remodeling and upkeep to make them suitable for storing servers. The company benefits from scale economies until it reaches the point where it has to build out more space or invest in more equipment. Then, the economies reset. In 2007, the company spent $105.4 million on property and equipment.

Rackspace didn’t really need to do this offering. The main uses of proceeds are $50 million in debt repayment and potential acquisitions. One of the venture investors and a few of the managers sold stock on the IPO, but that amounted to about two million of the 15 million shares offered. The largest venture firms, Norwest and Sequoia, as well as chairman Graham Weston, are not selling and together control about half of the stock.

Joining Goldman, Credit Suisse, and Merrill Lynch in the underwriting was W.R. Hambrecht, which structured the offering as an auction. In addition, the IPO was filed with a wide initial price range: $12.00 to $16.00. Nevertheless, the deal closed at $12.50, near the low end of the range, and the stock opened down in the first day of trading. In this market, techniques usually used to ensure a successful offering aren’t working. On Monday, Rackspace closed at $10.70.

Rackspace is profitable and growing, and it probably has opportunities to pick up more market share through acquisition. It may be worth a look at these prices.

Upcoming IPO

Consonus Technologies (Nasdaq: DCTI; scheduled for week of Aug. 11; $27.0 million estimated proceeds; $59.2 million estimated post-money valuation): Rackspace isn’t the only data center IPO out there. Consonus is a small data center provider that is hoping to go public in Rackspace’s wake. It operates three data centers of its own and leases space in several others. The company was formed through an acquisition. Consonus had $104.3 million in revenues in 2007, pro forma for the acquisitions, but it lost money on both an operating income and a pretax income basis. If this deal allows it to reduce some of its $43.1 million in debt, that might help. Doing the math, it seems that Rackspace raised enough money to pay off its debt, buy Consonus, and have a little money left over. So why the IPO in this market?