Rackspace Hosting, Inc. Slumps On Standalone News

Rackspace Hosting, Inc. Slumps On Standalone News

Rackspace Hosting, Inc. (NYSE:RAX) said this week that it will not continue seeking a suitor and instead plans to remain independent. The company has been conducting a strategic review for the last five months, and management decided that the best way to maximize value for shareholders was remaining alone. Along with the decision, they also promoted former President Taylor Rhodes to permanent CEO.

But even though the decision to go it alone seems to have turned many investors bearish on Rackspace, Morgan Stanley analysts see a number of positives from it.

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Rackspace Hosting is confident

In a report dated Sept. 16, 2014, analysts Simon Flannery and Lisa Lam said that by choosing to remain independent, Rackspace management is demonstrating how confident that re in their standalone business model. They note that recent records indicate that the company’s managed cloud services have plenty of support.

Management expects this year’s solid growth rate to extend into next year. They also expect margins to expand due to investments in greater capacity last year beginning to show returns. Because of their confidence, they reaffirmed the previously provided third quarter guidance.

Rackspace opts not to do buybacks

The company also decided not to start a buyback program so that it can remain financially flexible, even though its stock has a low valuation and investors aren’t really supportive. The Morgan Stanley team notes that Rackspace discussed this possibility heavily, but the company’s board decided that it was “improper” to raise a company with revenue growth in the high teens and “secularly strong future prospects” only for the purpose of returning cash to shareholders.

New CEO Rhodes also said he wanted to become more comfortable in the CEO role before he committed to an ongoing share buyback program.

Rackspace cleared for takeoff

The Morgan Stanley team points out that the overhang from the strategic review process is now over. Because Rackspace Hosting is able to just conduct business as usual from now on, they think it will begin ramping up marketing and partnership building initiatives.

In addition, they say talks with customers re much simpler now because the uncertainty about the company’s future has been removed. Investors, analysts and customers are now expecting more information about Rackspace’s plans at its Solve event, which is scheduled for tomorrow in New York.

Rackspace pressured, but just for now

The analysts note that most of the share price movement on Rackspace stock in the last five months has been due to speculation about the company’s future. They say because there is no longer the possibility of a deal, the bear thesis will likely return—and indeed it seems to have.

Nonetheless, they still like the cloud storage provider’s fundamentals because of last quarter’s strong revenue growth even though the strategic uncertainty remained. Also they note that there continues to be strong enterprise demand for cloud services, which provides additional opportunities for Rackspace Hosting.

The Morgan Stanley team maintains its Overweight rating and $45 per share price target on Rackspace.

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