Rackspace Hosting, Inc: Should You Buy This Takeover Target?

Rackspace Hosting  soared 7% in the closing minutes of Thursday's session after Bloomberg sparked acquisition speculation. While the company is no stranger to buyout talk, most recently with IBM , it continues to struggle against the likes of Amazon.com . But without a competitive edge, these new rumors are unlikely to be true.

What's the news?
Bloomberg Real M&A reported via Twitter that Rackspace has hired an advisor to evaluate "inbound strategic proposals". Supposedly, someone at the company contacted Bloomberg, and the tweet implies that Rackspace has received proposals of sorts, which investors perceive to be acquisition talks.

Notably, this report surfaced just days after Rackspace reported earnings that caused its stock to rise nearly double-digits, following revenue growth of 16.2%. Yet, if such proposals do exist, they are sure to fade as companies dig deeper into the fundamentals and business outlook of Rackspace.


Who wants Rackspace?
Rackspace operates in two key segments: Web hosting and cloud services, with the latter including cloud infrastructure, or laaS, and app platforms, or PaaS. The company's web hosting accounts for 70% of revenue, and is growing at a 10% clip. However, web hosting is becoming increasingly fragmented and competitive from a pricing standpoint.

Instead, investors focus on the company's cloud business, which grew 34% in its first quarter to $121.4 million. Essentially, this business is only growing at a 34% clip because the industry as a whole is increasing at a 50% rate annually. With that said, Rackspace's market share is marginal relative to industry leaders, and is shrinking by the quarter.

Further, Rackspace lacks any products that provide an operational edge relative to its peers in cloud, and it has failed to follow the pack and cut its prices. Specifically, industry leader Amazon controls more than 30% of the cloud, and is now generating well over $1 billion in annual revenue, and it's growing at more than 60% a year. Yet, despite this market dominance, Amazon recently announced its 42nd price cut in its history.

Thus, Amazon is growing its market share in a segment of its business that's worth an estimated $50 billion of its $135 billion market cap. IBM holds the third rank in cloud market share, and in its last quarter, saw growth of 80%. Like Amazon, IBM has had to cut costs, but has also been acquisitive of companies that fill a void in its service.

So with both of Rackspace's businesses challenged and its stock down 22% on the year, you have to wonder what company would want to buy Rackspace? Further, with the stock being so cheap, you must also consider why the company would be looking at offers now? After all, it seems as if the company's premium pricing strategy was working, so management should want to wait it out.

We've seen this before!
In the last two years, large telecom and tech companies have often been rumored to be interested in Rackspace, which includes IBM. In fact, IBM admitted last year that it had eyed both Rackspace and SoftLayer as potential acquisition targets. IBM eventually purchased SoftLayer, which put an end to the Rackspace speculation.

With that said, it shouldn't be a surprise that Rackspace is evaluating inbound proposals. But the real question is: How recent are those proposals and will any company make a legitimate and public offer once it digs into Rackspace's financials?

As an investor, it's always better to be skeptical of such rumors, and in this case, if it fails to materialize, expect Rackspace to continue its current path downward.

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The article Rackspace Hosting, Inc: Should You Buy This Takeover Target? originally appeared on Fool.com.

Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Rackspace Hosting. The Motley Fool owns shares of Amazon.com and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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