Rackspace's plans to raise $400 million are thwarted

13 Aug 2008

Rackspace Hosting Inc.'s initial public offering didn't provide much hope for a revived IPO market for technology companies. Lackluster debut not promising for other tech offerings, but stock could be undervalued.

After initially planning to raise $400 million in an IPO this year, San Antonio-based Rackspace raised $187.5 million Thursday night when its shares were priced at $12.50 each. That was on the low end of the $12 to $16 range the company expected to garner through its IPO auction.

On Friday, Rackspace shares sank nearly 20 percent from their offer price, closing at $10.01 in the company's first day of trading. The lackluster debut reflects investors' concerns about the stock market and the economy rather than any deep problems with Rackspace, said Dave Lincoln, an equity analyst with Morningstar Inc.

"There hadn't been an information technology service company launched (via an IPO) for the past six months," Lincoln said. "Investors are still a little bit wary of macroeconomic factors."

Morningstar's "fair value" price for Rackspace is $14, Lincoln said, giving investors a good post-IPO chance to invest.

Rackspace, which has operations in Austin, runs data centers that provide Web hosting and a range of computing services. The company's IPO had generated pre-launch buzz because of its consistent profitability and what Lincoln called "phenomenal" revenue growth.

Rackspace has been profitable for five straight years; in the quarter ended March 31, it reported a profit of $5.4 million on sales of $119.6 million, both big increases over the year-earlier quarter.

Besides worries about a deepening economic downturn, investors may have been turned off by the strong competition in the Web hosting and services business from companies such as Savvis Inc., The Planet, Equinix Inc. and Terremark Worldwide Inc.

Tech giants such Google Inc. and Amazon.com Inc. are also using their considerable resources to enter the hosting and services business, said data center analyst Rich Miller of Lawrenceville, N.J. He said Amazon, for instance, sells information-technology services based on the excess capacity it doesn't use except for the busiest sales seasons.

In a research note this week, Morningstar senior stock analyst Michael Hodel warned of "considerable uncertainty concerning Rackspace's future and the value of its shares."

"We aren't convinced the firm's strategy will provide it with a sustainable advantage over time versus the multitude of firms with which it competes," he wrote. Hodel also warned of a repeat of the 1990s overbuilding boom in data centers, which led to oversupply, price cuts and eventual ruin for companies such as Exodus Communications.

Miller discounted analogies to the dot-com-era boom and bust in data centers. "What is happening today is entirely different, and it's reflected in the nature of the companies building data centers now," said Miller, a tech writer and analyst who runs the Data Center Knowledge Web site and is president of Miller Webworks LLC. "The players in it are the companies that are specialists, they've done it before, and they are capitalized to go ahead and do it," he s

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