Rackspace (RAX) Shares Tumble 16% After Buyout Plan Dies

by Ryan Fitzwater, Director of Research, The Oxford Club

Back in July, in our Investment U Stock Grader column, we covered rumors that cloud service provider Rackspace Hosting Inc. (NYSE: RAX) was considering taking itself private. At the time, shares jumped more than 7% on the news that the acquisition would have a price tag of up to $6 billion.

Sad to say, today, the acquisition party is over. Yesterday, the company announced that it wouldn’t be selling itself. As a result, shares have plunged over 16% today.

Co-Founder and Chairman Graham Weston stated “The board decided to terminate merger discussions. We talked to a diverse group of interested parties and entertained different proposals. None of these proposals were deemed to have as much value as the expected value of our standalone plan.”

On top of that, the company also said it will not be authorizing a buyback program, noting that it would “siphon too much cash needed to fund growth.”

When mentioned two months ago that Rackspace was struggling with stiff competition from industry giants like Google (Nasdaq: GOOG) and Amazon.com (Nasdaq: AMZN), a buyout would have been a win for shareholders. But rumors and talks are just rumors and talks. And today, the gains the stock price saw over a potential buyout have been erased.

This is a perfect example of why you should perform fundamental analysis, along with other analysis, before you consider investing in a stock. Two months ago, you could have jumped head first into Rackspace just based on the news the stock could be bought out for a 27% premium over its current share price. And today, you would be kicking yourself.

At the time we made sure to run Rackspace through our Investment U Fundamental Factor Test and gave the stock a “Hold” rating after it missed on three key metrics.

Today’s sell-off might put the stock on the bargain rack, but since it reported earnings in August, let’s verify its fundamentals again to see where it stands:


Earnings-per-Share (EPS) Growth: Rackspace reported adjusted EPS of $0.16 in the most recent quarter, the exact same EPS it had over the same period last year. Better than last quarter when it saw earnings drop 10%, but flat earnings are not growing earnings. Hopefully it can turn this around next quarter.

Price-to-Earnings (P/E) Ratio: Last time we graded Rackspace, its P/E was 57.20. Today it is even higher, clocking in at 59.40 (this includes adjusting for today’s drop in share price). This is well above the industry’s average P/E of 37.65. It is looking very overpriced on an earnings basis, despite today’s price drop.

Debt-to-Equity Rackspace is still crushing it from a debt standpoint. Its debt-to-equity of 6.66% is way, way, way below the industry average of 328%.

Free Cash Flow Per Share Growth: Last time we looked at Rackspace’s FCF growth, it had knocked it out of the park with a 571% increase in FCF per share. In the most recent quarter, it boosted FCF $0.07 a share compared to a loss of $0.10 for the same period a year ago. That is what we like to see.

Profit Margins Another positive metric here. Rackspace’s ROE of 5.09% is better than its peers who are averaging 3.74%.

 Return on Equity : Rackspace is still underperforming on ROE. Its ROE of 8.08% is right below the industry average of 10.52%. Just like the last time we graded the stock, it is missing on the same three metrics we mentioned above.

*Why did we look at these specific metrics? Find out more here.

Fundamental Factor Test Score

C: Hold (Hits just three key metrics)

Please note that our fundamental factor checklist is just the first step in performing your own due diligence. There are many other factors you should consider before investing. That's why The Oxford Club offers over a dozen newsletters and trading advisories all aimed at helping investors grow and maintain their wealth. For more details, click here.

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