Arik Hesseldahl

Recent Posts by Arik Hesseldahl

Rackspace Is Not for Sale, but Thanks for Asking

Practically everyone who meets him asks Lanham Napier when his company is going to be sold. He’s the CEO of Rackspace, the Web hosting and cloud computing concern that’s one of several thought to be acquisition targets following the recent buyouts of Terremark by Verizon and NaviSite by Time Warner.

So many people have asked Napier about the possibility that Rackspace might be taken out, it’s not hard to detect that his answer is well rehearsed. Rackspace is not for sale, he says, and he won’t comment on any approaches by larger companies it may be fielding. But he clearly doesn’t mind the speculation.

The market certainly is working on the assumption that an acquisition is coming. I talked with Napier on Friday, the day after Rackspace reported quarterly earnings that grew 50 percent over the same period in 2009, which was enough to send Rackspace shares up by more than $3, or more than 8 percent, closing at $40.07–more than twice what it traded for a year ago.

Rackspace will be a giant all its own, Napier insists, before it gets taken out by one of the lumbering tech giants that might like to drop a few billion dollars to absorb it. Ask him Rackspace’s chances of being acquired in the next several months, and he insists the company is not for sale. It sure sounds like he means it, as the growth opportunity that lies before him is just so good. But it’s also clear that he enjoys being in the position of being asked.

It’s a nice sentiment, but organic growth is only going to get you so far. Rackspace will cross the billion-dollar mark in revenue for the first time this year, and it has only $105 million in cash, so the only acquisitions Rackspace can make without going into a debt are small ones like the one last week of Anso Labs that NewEnterprise reported exclusively. The smart money says we’ll get a chance to see how serious Napier is about remaining independent before the end of the year.

NewEnterprise: Let’s talk about your business against the backdrop of the industry you’re in. In the last few weeks we’ve seen both NaviSite and Terremark acquired by larger companies. Clearly there’s some consolidation going on in the Web hosting and cloud services hosting business.

Napier: There is a shift in technology market around cloud. The market is shifting from one where companies do things themselves to buying technology as a service. We think of it as a world that’s going from buying inputs to buying outputs. We think this is a nascent trend and we’re in the first game of a seven-game series. On a macro basis we see this as the biggest growth opportunity in technology. Our strategy is to win the most valuable segment, which we believe is going to be the service segment. So if you look at how the market is developing, you have players like Amazon that’s offering a do-it-yourself cloud. For people who want the lowest price, and can do the work themselves, Amazon is an incredible pick. What we’re focused on is trying to be a service leader. We want to serve companies that want to run a critical app and who want us to run it for them and take accountability for it so they can sleep well at night. Over the past six quarters or so we’ve found ourselves in a crazy good spot. The growth opportunity ahead of us is expanding.

Let’s talk about growth. You don’t have all much cash on the balance sheet, about $105 million or so. You can grow organically, or you can acquire. You’ve made some small acquisitions recently. Is that going to continue?

We are an organic growth company. We have been since inception. The acquisitions we’ve done have been about technology and talent to improve our portfolio and the way we serve customers. We will remain an organic growth company. There are, I think, really two kinds of companies. Those that can grow organically and those that can’t, and so they grow by acquisition. Some companies are good at growing through acquisition. We’re just not. We’re organic growth folks here, so we’re going to stick to that. But we’ll still buy technology, capabilities and talent that we think is critical. As to the consolidation that’s taking place in the industry, it’s a great validation of the growth opportunity. There are some legacy tech and telecom companies that are behind and are trying to buy their way into the game. There was a similar wave of consolidation eight years ago and a lot of our competitors got taken out.

So let me ask the question you’re getting a lot lately. I’ve had three conversations with different people who have each picked three different large technology companies they think should acquire Rackspace. Have you been approached by anyone?

We have a policy not to comment on anything like that all. What I will tell you is that we’re not for sale. We feel like we have a tiger by the tail. I’ve been lucky to be at the company for 11 years and I think the next 11 years look better than the last. We’re not building the company to flip it. We think the market opportunity is such that new giants are going to emerge, and we want to be one of those giants.

Absent a scenario that someone shows up with eight or 10 billion in cash to buy your company, what are your strategic priorities for the year?

There’s a couple. We are making big investments in our product and service portfolio. That’s one. And then number two, we think we have a chance to improve the fundamental economics of our business model. As we make these investments, we’ll add more services and capabilities on top of our basic compute service. This drives up the average revenue for our basic compute which creates better outcomes for our customers and increases our economics. It’s a virtuous cycle. Our average revenue per server has increased for six consecutive quarters.

What are your biggest costs, and what kind of gross margin do you tend to run?

I think of them as investments, but I know that’s just semantics. Our no. 1 investment is technology and the Rackers [employees] that serve our customers. So if you look at the cost of revenue line, a year ago it was 31.5 percent. As of the end of 2010 it was 31.1 percent. We made some improvement. But we’re more focused right now on developing customer loyalty than we are in driving efficiency. It’s early in the game, and anytime a market is going through a period of rapid growth like this, it’s all about winning as many loyal and profitable customers as we can. When the growth slows down someday we’ll focus more on improving efficiencies throughout the business. Even so, in 2010 we grew faster, increased our margin and and improved our return on capital. Those are all difficult things, and we pulled it off.

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