Apollo spies a bargain in $4.3bn Rackspace price tag

Apollo’s take-private transaction with the cloud computing company shows a discounted price, but for a company in the midst of a strategic transition that remains unproven.

Apollo Global Management along with Searchlight Capital Partners have agreed to purchase cloud company Rackspace at a discounted price, but in doing so, they are betting on the company successfully completing its strategic shift.

The New York-based private equity firms are acquiring the company for $4.3 billion, or $32 per share. While this per-share offering price is a 38 percent premium to Rackspace’s closing price on 3 August – before rumours of a transaction – it represents a discount compared to acquisitions involving the company’s peers, according to several equity research reports.

The $32 per share price represents about 6.7 times the 2016 earnings before interest, tax, depreciation and amortisation as estimated by investment bank Raymond James. By contrast, the bank indicates Rackspace’s peers have recently been sold for 10 to 14 times EBITDA.

“We believe they are getting in at a low price, but in return are buying into a strategy that has yet to be proven out and will still arguably take several quarters if not years to do so,” added another investment bank Cowen and Company in its research report.

Rackspace hired bankers to evaluate strategic alternatives in 2014 and has since shifted from offering a public cloud platform to focusing more on IT customer service for the cloud. This transition is still in early stages, Cowen wrote. 

However, as a private equity buyer, Apollo can afford being early in the strategic shift – considering the typical private equity holding period – while a strategic buyer “would have almost immediately suffered from the same scrutiny Rackspace has,” Cowen added.

Despite higher valuations given to other cloud-based assets, Raymond James said it does not believe additional bidders will emerge, as “all financial and strategic buyers” had already been sought out. The Cowen report also indicates the deal lacks a “go-shop” period, in which the seller can solicit higher bids before close, meaning the price is likely to be final.

Terms of the transaction, which is expected to close in the fourth quarter, were not disclosed.

A source familiar with the matter told Private Equity International that Apollo is investing in Rackspace using Apollo Investment Fund VIII, which closed on $18.38 billion in 2014 and seeks value-oriented opportunities in distressed investments, corporate carve-outs, and opportunistic buyouts. 

Rackspace is the sixth take-private transaction the firm has participated in this year.

Before Rackspace, Apollo’s most recent take-private deal in the information technology sector was Presidio, in February 2015. Last month, the firm agreed to buy self-service vending machine operator Outerwall for $1.4 billion in another take-private deal, as reported by PEI.

Apollo manages about $186 billion in assets as of 30 June.

PEI data indicates that Searchlight is currently investing its second fund, Searchlight Capital II, which closed on $1.94 billion in 2015.

Apollo and Searchlight declined to comment beyond the press release, and a spokesman for Rackspace was not available to comment.

Citigroup, Deutsche Bank, Barclays, Royal Bank of Canada, and Public Sector Pension Investments Credit USA – a US-based affiliate of the Canadian pension PSP, are providing undisclosed financing for this deal.