U.S. Markets open in 5 hrs 21 mins

Third Point Partners starts new position in Rackspace Hosting

Smita Nair

Overview: Third Point Partners' positions in 2Q14 (Part 3 of 8)

(Continued from Part 2)

Third Point Partners and Rackspace Hosting

Dan Loeb’s Third Point Partners added new positions in Ally Financial (ALLY-B), Rackspace Hosting (RAX), IAC/InterActiveCorp (IAC), and FMC Corp. (FMC) last quarter. Notable exits included Verizon Communications (VZ), Cabot Oil & Gas (or COG), and International Paper (or IP).

Third Point Partners initiated a new position in Rackspace Hosting (RAX) last quarter. It accounts for 3% of the fund’s total second quarter portfolio.

Rackspace is a leader in managed cloud. It’s the founder of OpenStack—the open-source operating system for the cloud. It offers a diverse portfolio of cloud computing services including public cloud, dedicated cloud, private cloud, and hybrid cloud. All of the services are committed to open technologies. The equipment—servers, routers, switches, firewalls, load balancers, cabinets, software, and wiring—required to deliver services is typically purchased and managed by the company. Rackspace is headquartered in San Antonio, Texas. It operates data centers on four continents.

In 2013, Rackspace had a net revenue of $1.5 billion. As of December 31, 2013, it served more than 200,000 business customers and managed more than 103,000 servers. For the first half of 2014, more than 32% of its net revenue was generated by operations outside of the U.S.—primarily from the UK. Its growth strategy includes targeting international customers for expansion in continental Europe, the Asia-Pacific region, and Latin America.

Rackspace sees activist interest

Recently, activist investor Blue Harbour Group LP filed a 13D revealing a 6.4% stake in Rackspace. The filing said the hedge fund plans to pursue discussions related to the company’s “business, management, capital structure and allocation, corporate governance, board composition and strategic alternatives and direction, and may take other steps seeking to bring about changes to increase shareholder value.”

Rackspace had said back in May that it “has been approached by multiple parties who have expressed interest in exploring a strategic relationship with Rackspace, ranging from partnership to acquisition.” The company has hired Morgan Stanley “to evaluate the inbound strategic proposals and to explore other alternatives that could advance Rackspace’s long-term strategy.”

New managed cloud strategy

The company has seen investor concerns over increasing competition from technology companies like Amazon, Hewlett-Packard, Google, IBM, and Microsoft. These companies have made substantial investments in cloud computing offerings and initiatives.

In July, Rackspace announced a new strategy to deliver public cloud services to the market based on its core strength in customer service—known as Fanatical Support. This was in response to reports that competitors—Amazon, Google, and Microsoft—drastically cut prices for the commodity cloud market.

Rackspace launched a more transparent service-based pricing model that represents a clear view of infrastructure pricing. It emphasized the value of Rackspace’s cloud management expertise. It said that its service levels—managed infrastructure and managed operations—feature more services and expertise at lower total cost than companies would spend managing cloud operations on their own. The company also announced Developer+—a new program for developers that offers essential services needed to build scalable applications.

In July, the company also announced the general availability and pricing of OnMetal Cloud Servers—an application programming interface (or API)-driven, single-tenant Infrastructure-as-a-Service (or IaaS) offering.

Revenue and earnings beat estimates, but margins decline

Net revenue for 2Q14 was $441 million—up 4.8% from the previous quarter and 17% from 2Q13. Net revenue was positively impacted by currency exchange rates. Net income was $22 million for the quarter—down 11.8% from the previous quarter and flat year-over-year (or YoY).

The company added new customers during the quarter. Notable wins included WP Engine, WePay, and Zulily. However, margins declined sequentially.

Management noted on the earnings call that “Adjusted EBITDA for the second quarter was $142 million, reflecting a margin of 32.1%. Net income was $22 million or $0.16 per share, reflecting a margin of 5%. Compared to the first quarter, second quarter profit margins were negatively impacted by higher headcount related cost, professional fees and software license expenses.”

For the third quarter, Rackspace expects sequential revenue growth of 3%–4.5%. This will result in total revenue of $454–$461 million. In terms of profitability, adjusted earnings before interest, taxes, depreciation, and amortization (or EBITDA) margins are forecast to be 31%–33%.

Continue to Part 4

Browse this series on Market Realist: