Last week Rackspace Holding Inc. (NYSE: RAX) announced that the company had hired an advisor, which translates usually to an investment banker. This is to help evaluate strategic options, which in the Wall Street lexicon means to find a buyer or a company willing to merge. Of course the stock immediately traded higher, and short-sellers had to head to the exits or risk getting crushed if a deal is made. In a research note from Credit Suisse, analysts think that Rackspace hybrid cloud offerings could be a very attractive asset to some big, old-school tech firms looking to expand their business — especially companies looking to be bigger players and expand their cloud computing capabilities.
Here are three companies that the Credit Suisse team thinks could be active in pursuit of a deal with Rackspace.
Cisco Systems Inc. (NASDAQ: CSCO) finally stepped up to the earnings plate and hit the ball out of the park. The company’s recent earnings surprise helped to lift the stock after many disappointing reports over the past year. The networking giant could prove to be a good match with Rackspace as it is expanding its business in scale all over the globe. In addition, changes in technology make adding a large cloud computing entity a smart move for the Silicon Valley veteran. With more than $50 billion in cash, needless to say the company has the wherewithal to get a deal done. Investors are paid a 3.1% dividend. The Thomson First Call price target for the stock is $24.99. Cisco closed trading Friday at $24.37 a share.
Dell was finally taken private after years of decline, as the PC business has slowed, and the awkward $3.9 billion acquisition of Perot Systems proved to be a difficult integration. Going private last fall gives the company more flexibility in making an acquisition, but an onerous addition of debt to get the deal done might prove to be a difficult task. Michael Dell’s private equity partners at Silver Lake could be added back to the line-up for a purchase of Rackspace, and the deal would certainly help expand the company’s earnings potential. That being said, if Silver Lake steps up, you might see Dell as a public company again in the next five years.
Hewlett-Packard Co. (NYSE: HPQ) is another Silicon Valley veteran that has returned to prominence over the past two years, and it may prove to be the best fit for Rackspace. CEO Meg Whitman certainly deserves a pat on the back for finally putting the brakes on the company’s continued revenue slide, but the return to consistent profitability still seems to many like an elusive dream. With revenues from the enterprise and printing divisions lagging in the first quarter, bolstering cloud computing and the growth it could provide may be the perfect fit for the company. Especially after the company recently announced a $1 billion initiative to develop its very own cloud-computing products and services. Buying and integrating Rackspace may be a much easier path. With $24 billion in debt already, it could strain the company from a debt service viewpoint, so a cash and stock deal would likely make the most sense. The stock pays investors a 2% dividend. The consensus price target is $34.11. The company, which reports second-quarter earnings this week, closed Friday at $32.52.
The Credit Suisse team cited other purchases of cloud computing companies that were done at 14 and 10 times earnings. At a minimum, they think Rackspace would garner a premium to the data center colocation average multiple of 10.9 times earnings, implying a $47 acquisition price. You can bet that the arbitrage funds are sharpening their pencils and getting ready to pounce if a deal is struck. Aggressive investors may want to buy Rackspace stock or out-of-the-money calls in an attempt to play this possibility.