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Shares of the cloud computing company Rackspace jumped more than three percent today apparently on yet another round of speculation that Hewlett-Packard may be interested in buying it.
Sources with direct knowledge of HP’s plans — or in this case, lack of plans — told Re/code on Friday that nothing has changed in its view of Rackspace since our report in July: It has no interest in acquiring it, not then, not now.
Here’s what has got the markets in a tizzy: In comments on a conference call with analysts Wednesday, after it reported its third-quarter results, HP CEO Meg Whitman reiterated what she has said before: “Acquisitions will be part of our future.”
On top of that, there was this tasty morsel from CFO Cathie Lesjak. To explain why HP bought back about half as many shares during the third quarter as it has in prior quarters, Lesjak said, “During the quarter we were limited in our ability to purchase shares due to material non-public information.”
Combine those two statements and hilarity ensues. Some observers concluded that HP had made a move on an acquisition during the quarter that either wasn’t consummated or has yet to finalize. HP hasn’t said what the “material non-public information” is — and believe me, I asked.
So back to Rackspace for a moment. The speculation goes like this: Since rival IBM spent about $2 billion last year to acquire the cloud computing services player SoftLayer, HP was seen as needing to respond with a similar cloud acquisition of its own. Since that deal closed last year, Big Blue has been going on a cloud services tear. All of its applications are running in the SoftLayer cloud. It’s spending big to boost SoftLayer’s global footprint, and even bragging that by its own measure its cloud is bigger than that of Amazon Web Services.
By comparison, HP is seen as a laggard in the cloud services game, a sector that has eaten away at HP’s enterprise hardware business as big corporations stop buying their own machines and farm their computing out to third parties in order to save money. The research firm Gartner has listed HP as a “niche player” on its closely watched Magic Quadrant of cloud players.
Meanwhile, Rackspace has been actively shopping itself around since May and even hired the investment bank Morgan Stanley to run the process. So far there have been no takers. Activist investors have been building up their stakes in Rackspace assuming either an acquisition or a leveraged buyout is coming.
Rackspace, the thinking goes, would be the kind of acquisition that would vault HP a little higher and to the right on that Magic Quadrant.
Except that it won’t. Rackspace may boast a market capitalization of about $5 billion, which, after accounting for a premium, would put the hypothetical purchase price at more than $6 billion. But it’s not very profitable for a cloud services player. Rackspace over the years has tended to report gross margins of about 67 percent on a revenue base of about $1.5 billion a year.
Although no one knows exactly what kind of profit Amazon gets on AWS, educated guesses have pegged it at 90 percent, and I’ve made my own arguments about why I think IBM’s gross margins at SoftLayer may be in the same ballpark.
Rackspace’s profit margin is lower because it prides itself on providing intense service and support to its customers, and that logically leads to a lower profit margin because high-touch service and support doesn’t come for free.
On top of that, there’s not really all that much unique that Rackspace offers that HP can’t build for itself. HP has its own hardware, and the OpenStack cloud operating system to which it has hitched its cloud is free. Why not just build a cloud service based on OpenStack, spend some money to build out the infrastructure and grow the business from scratch? Indeed, that’s exactly what it’s doing: It announced in May it would spend $1 billion to build its cloud brand Helion.
Finally, Rackspace looks exactly like the kind of messy acquisition that HP, following the $11 billion Autonomy debacle, would seek to avoid. In February, Rackspace experienced a bizarre management shake-up where CEO Lanham Napier retired suddenly and was replaced by Chairman Graham Weston, a co-founder who owns about 13 percent of the company.
No one has documented what prompted Napier’s resignation, but it is easy to imagine how the optics could scare off HP.
Correction: This story previously identified the former CEO of Rackspace as Alan Napier, not Lanham Napier. Sorry about that.