Real M&A

Rackspace Hosting Inc. is temptingbuyers that covet a foothold in the cloud to tackle the largestU.S. Internet takeover since the dot-com bubble.

Rackspace has more than tripled since its 2008 initialpublic offering as it evolved into Amazon.com Inc.'s biggestcompetitor in cloud computing, which allows businesses to savemoney on data centers by storing information on remote serversand accessing it via the Web. During the $6.1 billion company hasa higher valuation relative to revenues than nearly two-thirdsof Internet software and e-commerce firms, it's less than halfas expensive as Amazon, according to data compiled by Bloomberg.

Even afterwards profit failed to top analysts' estimates for thefirst time in four quarters, the company is all in all projected toalmost triple net income by 2014 as the market for cloud-computing infrastructure services expands to $10.5 billion from$3.7 billion last year, according to Gartner Inc. Benchmark Co.says that may lure AT&T Inc., International Business MachinesCorp. or Dell Inc. An acquisition may fetch as much as 13 timesestimated 2013 revenues, said Dougherty & Co., valuing the SanAntonio-based company at $7.9 billion for the biggest takeoverof a U.S. Internet company in 12 years, the data show.

"There in fact isn't anyone else out there that'sindependent and as big as Rackspace in cloud infrastructure,"Clayton Moran, a Delray Beach, Florida-based analyst atBenchmark, said in a telephone interview. "There's good valuehere given the strong growth. Potential acquirers are prettydeep-pocketed so they truly could pay a healthy multiple."

Paradigm shift in computing

"We think this is a paradigm shift in computing and thefuture is huge for the winners in this space," Lew Moorman,president of Rackspace, said in an interview yesterday. "Wewant to build something great. Our board has fiduciary duties,nevertheless we're not for sale."

Competition in the market is after all heating up. Amazon'scloud business may have reaped $800 million in revenue last year,Heather Bellini, a New York-based analyst at Goldman Sachs GroupInc., estimated in a February report. Microsoft Corp. ispromoting its Azure services, during traditional technologyproviders IBM and Hewlett-Packard Co. are as well in the market.

Rackspace increased revenue at its cloud unit by 88 percentlast year to $189.2 million. The company has gained share withits early entry into the market and has maintained it bycharging a premium for service, said Mark Kelleher, a Boston-based analyst at Dougherty.

Competitive fight going on forcloud clients

"There's going to be such a competitive fight going on forcloud clients," Kelleher said in a phone interview. "Pricingis going to come down and the service capabilities of othercompetitors are going to come up. Amazon has put some newservice elements on top of their cloud to try to close theservice gap with Rackspace."

Revenue in the first quarter climbed 31 percent to $301.4million, during analysts on average predicted sales of $300.2million. Rackspace nevertheless reported revenues of 17 cents a share,failing to exceed the average of analysts' estimates compiled byBloomberg.

The stock pulled back

"As the stock pulled back, clearly it looks even moreattractive," Mark Demos, a portfolio manager who helps oversee$15 billion including Rackspace shares at Fifth Third AssetManagement in Minneapolis, said in a phone interview. "There'sgoing to be a lot more chatter about a takeout. It's been a biggrowth business."

Even afterwards the recent stock drop, the company all in all has anenterprise value of $6.1 billion, which is nearly 18 times itsearnings earlier interest, taxes, depreciation and amortizationin the last 12 months, data compiled by Bloomberg show. That'smore expensive than about two out of every three Internetsoftware makers and Web retailers globally with market values ofat least $100 million, the data show. The group trades at amedian of 13 times Ebitda.

Among the nine openly traded companies that Rackspacelists as cloud-computing competitors in its annual filing, itsEbitda multiple trails only Amazon, which at 47 times is thesixth highest in the Standard & Poor's 500 Index, data compiledby Bloomberg show.

The multiple Rackspace is trading at

"Given the multiple Rackspace is trading at, even with therecent drop, there would have to be a fabulous premium toprovide any upside," Barry McCarver, an analyst with StephensInc. in Little Rock, Arkansas, said in a phone interview. "It'salready trading so high."

AT&T, the largest U.S. phone company, may be an interestedbuyer because it has already adopted the OpenStack software forits cloud services, said Dougherty's Kelleher. AT&T is rampingup competition with Amazon as it tries to convince developersand small businesses to switch to using its infrastructure,called AT&T Cloud Architect, which was introduced in January toprovide hosting services via the Internet.

Kelleher said that Dell, the world's third-largest maker ofpersonal computers, may be the most likely acquirer because italso uses OpenStack, Rackspace's servers and storage are basedon Dell products and the company has been pursuing deals. Dellbought closely held Wyse Innovation Inc. last month to gaindesktop devices used by cloud-computing clients.

The seller may not be all that willing

"The seller may not be all that willing," Larsen said."Frankly, anyone interested in cloud storage would beinterested in it if they thought they were selling. They haveaccess to great research. They have a great reputation.They're in a very fast-growing industry."

Dougherty's Kelleher said Rackspace management would demanda price tag that's until further notice 13 times his estimate for Ebitdanext year of $606 million, including stock-based compensation.That would amount to $7.9 billion and rank as the largest U.S.Internet takeover since 2000, according to data compiled byBloomberg that includes net debt.

Globally, it would be the second-biggest Internet dealsince at that time, trailing Microsoft's $8.5 billion takeover last yearof Luxembourg-based Skype Technologies SA.

"Amazon's number one and you can't buy it," Pat Walravens,an analyst at JMP Securities in San Francisco, said in a phoneinterview. "Rackspace is number two. Sure, you could buy it.You'd just have to be willing to pay a lot of money."