As Rackspace Sells to Apollo for $4.3B, Locals and Cloud Feel Impact

San Antonio—Even though it now has more than $2 billion in annual revenue, Rackspace is a company whose roots are in the nimble startup world. That’s epitomized by a decision in the late 1990s, when the company’s co-founders—Richard Yoo, Dirk Elmendorf, and Pat Condon—transitioned the business from being an Internet service provider and app developer to doing Web hosting.

As we know now, it’s big business to help companies manage the vast amounts of data they use on physical and cloud-based servers. But the information technology landscape has changed, and now Rackspace (NYSE: RAX) faces a slew of competitors offering similar cloud-based services, from Amazon to Microsoft to IBM.

While the company has come up with some ways to make money even as competition rises (more on that later), it announced a deal Friday that may portend its most substantial changes to date: Rackspace is selling to private equity for $4.3 billion. Funds associated with New York-based Apollo Global Management are paying $32 per share to take Rackspace private, according to a statement released today. The board of directors has already approved the deal and the company expects it to close, pending shareholder approval, in the fourth quarter.

Exactly how the business will change under Apollo’s ownership is unclear. Funds associated with another private equity company, Searchlight Capital Partners, have made an equity investment in Rackspace alongside Apollo. The investment firms indicated they plan to keep current Rackspace president and CEO Taylor Rhodes on staff, and want to advise him on the company’s path forward.

“We look forward to working with Taylor and the entire management team and Searchlight to help advance Rackspace’s strategy,” David Sambur, a partner at Apollo, said in the press statement. A media representative for Apollo did not return a request for additional comment.

The acquisition fits in line with public statements that Apollo CEO Leon Black has made recently: the private equity giant is finding lots of attractive deals in a variety of industries. The firm paid $1.6 billion for Outerwall, the owner of Redbox, just a month ago. It is rumored to be bidding for Hewlett Packard Enterprise, according to Fortune.

For Rackspace, the ability to be taken private is appealing, allowing it more flexibility to “manage the business for long-term growth and enhance our product offerings,” Rackspace chairman Graham Weston said in the statement. Weston and Morris Miller, who is now CEO of Xenex Disinfection Services, were early angel investors in (and co-founders of) Rackspace.

For some 300,000 business customers worldwide, Rackspace builds and manages cloud-based IT infrastructures—public, private, or dedicated—that are hosted by its 11 data centers. In recent years, the company has been facing pressure from investments being made in cloud computing by Amazon, Google, HP, IBM, and Microsoft. Amazon emerged with Amazon Web Services, Microsoft with its Azure platform, and Google with its Google Cloud —all aiming to help people and businesses store and process massive amounts of data on their cloud servers.

One way Rackspace has mitigated losing revenue to those larger players is by working with them. It does that through its customer service offering, branded by the company as “fanatical support.”

Coined in 1999 by David Bryce, the former head of Rackspace customer service, the term became an internal rallying point for Rackspace employees—something to motivate them to always answer the phone, show customers they care and are passionate, and be committed to the customer, according to Miller, the investor who also served in multiple executive roles at the company.
https://www.rackspace.com/about/history

In October 2014, Rackspace announced an agreement to offer support to customers of Google Cloud, specifically its workplace productivity suite Google Apps for Work. That was followed in 2015 by deals with Amazon Web Services and Azure, and others this year. The work it does with competitors like Google and Amazon allows Rackspace to make money on its customer support side, even if isn’t on the hosting.

Rackspace believed that its customer service offering could stem declining revenue growth; its revenue increased by only 11.5 percent in 2015 over 2014, while it increased by 16.9 percent in 2014 over 2013. While Apollo didn’t provide any clear indication that the support side of the business would necessarily remain a focus, Sambur said the investment firm has respect for the Rackspace employees’ ability to “deliver expertise and exceptional service for the world’s leading cloud platforms.”

Miller, meanwhile, says that Rackspace’s success shows that customer service still matters, even in the modern era.

”Service, commitment, and going above and beyond is something that the buying public wants and is willing to pay for,” Miller wrote in an e-mail to Xconomy after the acquisition was announced. “This successful sale of the company is a reflection of [Rackspace employees’] daily work and commitment to delivering and extraordinary experience through Fanatical Support.”

Rackspace has a substantial footprint in the tech community and the broader startup scene, both in Texas and nationally. The company astutely observed that if it provides free hosting services to companies that qualify for nationwide incubator and accelerator programs—from Y Combinator to Techstars—it might be able to hook those startup founders to its hosting and customer service offerings. (Wade Roush explored the Rackspace Startup Program, which was developed in 2011, for Xconomy in 2013.) The approach also led to some of Rackspace’s most notable startup acquisitions.

In San Antonio, the company’s presence has changed the landscape of the workforce and business culture. Multiple former Rackspace employees have moved on from the company to lead or start other businesses, including coding schools, business services for software developers, affordable housing projects, and social media service offerings.

That’s not to mention the various other services Rackspace helped establish, such as a training program for people considering a career in IT, called Rackspace Cloud Academy. Weston, the chairman, helped launch Geekdom, the downtown co-working space that houses many of the burgeoning tech and healthcare startups that are beginning to spring up throughout the Alamo City. It is run by another former Rackspace employee, Lorenzo Gomez.

Rackspace also provided funding and people to help launch Tech Bloc, a local tech advocacy organization. Former Rackspace president Lew Moorman was a co-founder of Tech Bloc. Rackspace has had a similar impact on San Antonio to the one that Dell had on Austin in the 1990s, says Tech Bloc CEO and co-founder David Heard. Dell recruited high-caliber tech talent to the city, and it resulted in many workers eventually leaving to found their own startups, he says.

“A lot of those companies have become a big deal,” Heard says, referring to the Austin startup scene. “That’s already happening in San Antonio due to Rackspace, and a lot more is yet to come.”

Because many Rackspace shareholders are locals, there is potential that some of the cash windfall from the sale will be reinvested into local startups, says Blake Yeager, the managing director of the Techstars Cloud accelerator program in San Antonio. And because deals like this often result in changes in the acquired company, it may also mean that trained, talented workers will be looking for opportunities outside of Rackspace, Yeager says.

“These factors may provide two of the much needed ingredients to continue to grow a successful startup ecosystem, capital and talent, which bodes well for the future of San Antonio,” he wrote in an e-mail.

The sale is a conclusion to a long journey, which started in 1997 when the idea for a company was developed by Yoo, Elmendorf, and Condon, who all attended San Antonio’s Trinity University, according to Miller, who served as president, co-CEO, and co-chairman during his time at Rackspace.

After the deal was announced, Elmendorf tweeted: “What an amazing ride…”

 

David Holley is Xconomy's national correspondent based in Austin, TX. You can reach him at dholley@xconomy.com Follow @xconholley

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