Rackspace (RAX) LBO Math is Compelling at $32/Share, Says Wells Fargo

(Updated - August 5, 2016 9:19 AM EDT)

Well Fargo analyst Gray Powell thinks a Rackspace (NYSE: RAX) LBO at $32 per share could be justified using fairly conservative assumptions. Comments follow rumors that suggest the company is close to be acquired by private equity.

"Discussions of a RAX take­out have surfaced in the past (i.e. mid 2014) and failed to materialize. While details are limited, we think the potential is probably more real this time than not due to RAX's valuation, low leverage and FCF profile," said Powell.

Powell's LBO scenario assumes:

• "$32/share equates to a RAX enterprise value of $4.3B. A 30% equity stake implies net leverage of only 4.0x 2017E EBITDA, which is relatively low for an LBO.
• Given RAX's current free cash flow profile, for a private equity firm to realize a 25% annual return over three years, they would need to exit RAX at an enterprise value of $5.3B in 2019.
• In 2019, RAX could conservatively generate $330MM in unlevered free cash flow (assuming only 5%/yr average revenue and EBITDA growth, capex at 15% of revenue and a 30% cash tax rate).
• This would imply an exit multiple of 16.0x EV/unlevered FCF in 2019 and compares to RAX shares which have traded between 15.5x and 18.0x EV/2016E unlevered FCF YTD 2016."

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