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Will Rackspace 2.0 Be the Next Big Tech IPO?

By Eric Volkman – Apr 19, 2018 at 11:11AM

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The cloud storage company could be heading back to the stock market soon.

Are we back in the late 1990s? It almost feels like that; some of the most notable initial public offerings (IPOs) recently have come from the tech sector. According to research from IPO specialist Renaissance Capital, they account for one-quarter of the IPOs hitting the market over the past year.

Private equity operator Apollo Global Management (NYSE: APO) is apparently gazing in that direction -- it's considering a fresh IPO of its cloud computing management company Rackspace.

Rackspace logo

Image source: Rackspace.

Living in the cloud

According to a Bloomberg report, citing "people with knowledge of the matter," Apollo is in early discussions with advisors on bringing Rackspace back to the stock market. It might aim to accomplish this by the end of the year, said Bloomberg's sources. Rackspace's enterprise value could touch $10 billion, they added. The report was light on details, probably because it's still early on in the process.

Rackspace should be a familiar name to investors active in the tech arena. It originally came on the scene in a 2008 IPO. After that, it became a prominent name in cloud computing, particularly since it offered its colorfully named "fanatical support" for its clients. 

However, it started to face increasingly tough competition as giants Amazon (NASDAQ: AMZN) Web Services (AWS) and Microsoft (NASDAQ: MSFT) became more aggressive in the segment.

In a case of "If you can't beat 'em, join 'em," Rackspace pivoted into a third-party company specializing in the management of AWS, Microsoft Azure, and other popular cloud offerings. This was a more sensible approach, but it didn't help the stock price much. In 2016, Apollo swooped in, taking the company private for $4.3 billion.

Since then, say Bloomberg's sources, Rackspace has "performed very well." Of course, since it is no longer publicly traded, concrete figures are not available.

In the immediate pre-Apollo period, the company was growing and profitable, in spite of its unpopularity. Its last reported fiscal quarter saw net revenue rise 7% on a year-over-year basis (to nearly $524 million). On the back of a demand for those managed services that was "scaling rapidly," according to the company, net income zoomed 26% higher to almost $36 million.

We can assume, if Rackspace has indeed "performed very well," that it will offer a compelling investment thesis in its IPO -- it's a profitable (and perhaps still growing) company that piggybacks on a set of services that enjoy robust demand. 

That should attract attention, but will it be enough to make it a worthy investment?

This Fool's take

It isn't every day that a reliably profitable operator with some name recognition and a set of big partners makes it to the stock exchange. On top of that, Rackspace operates in a segment that should grow at healthy rates. According to forecasts from IT researcher Gartner, global revenue from public cloud services should rise from $260 billion in 2017 to almost $412 billion in 2020.

There's a big "but" next to these positive factors, however. Rackspace these days is more or less a company serving big-name cloud services providers like Amazon and Microsoft. So that begs the obvious question -- why would investors choose it as a play on cloud services over the stock of its big-name clients?

Putting money in Amazon instead would not only give an investor a piece of AWS, but also loop them into the company's mighty retail operations. And an investment in Microsoft buys a piece of a company that's one of the most consistent cash generators on the scene.

On top of that, Rackspace's debt could be a worry. In 2015, with an almost squeaky-clean balance sheet it took on nearly $500 million in new borrowings for "general corporate purposes," a category which possibly covered the $1 billion share repurchase program the company announced previously.

Since then it appears to have increased that debt with the acquisitions of two privately held companies, enterprise application specialist TriCore Solutions and managed services provider DataPipe.

This would concern me for two reasons; 1) it indicates that management feels the only way to meaningfully improve results is through buyouts, not organic growth, and 2) it makes the debt pile that much higher, and harder to tame.

Regardless, those interested in, or merely curious about, the company should read its S-1 filing(s), the regulatory document(s) that it will have to issue in advance of an IPO. These documents will show concretely how Rackspace's business has developed during the Apollo years.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Eric Volkman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

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