Why RackLink might not be such a good idea after all

Upon first glance, when news broke over the weekend that CenturyLink was weighing a bid for Rackspace, a deal sort of made sense.

[company]Rackspace[/company] is looking for more scale to bring it closer to the big guys — [company]Amazon[/company], [company]Microsoft[/company]et al. And [company]CenturyLink[/company] would love some of those Rackspace customers.

But, as some have since pointed out, with Rackspace market cap in excess of $5 billion, this would be a very expensive purchase for a buyer with not-so-much  cash (about $5 billion for its most recent quarter)  and a whole lot of debt — nearly $21 billion.  A lot would depend on whether Rackspace would accept a stock deal and if CenturyLink would take on more debt to make this happen.

There are other non-fiscal reasons a successful combination of Rackspace and CenturyLink would be difficult to pull off. For one thing, Rackspace has been wearing its OpenStack cloud strategy proudly. Meanwhile, CenturyLink partners with VMware on vCloud Hybrid Services (now known as vCloud Air), and it now also has its own cloud based on its orchestration technology — neither has much to do with OpenStack.

All of that plus Rackspace OpenStack stuff would provide a lot of customer choice, but is also a lot of technology to run and manage.

Skeptics decry [company]CenturyLink[/company] as an old-school telco trying to buy its way into cloud at whatever cost. But that doesn’t mean this acquisition won’t happen. “Never underestimate the desire of companies to make deals,” said  Jeff Matthews, general partner with RAM Partners, a Naples, Fla.-based investment firm. And, he added, “Rackspace needs to be bought.”

Gigaom Research Analyst David Linthicum said large companies will ignore debt if they believe the business objectives are sound. “If CTL and RAX believe that the combining of resources will be a 1 + 1 = 3 kind of thing, they will find a way to do it. Keep in mind the driver for these guys is value to shareholders, which are executives and employees as well — debt be damned,” he said via email.

Or something quite different could happen. Re/Code’s Arik Hesseldahl posited that a stock buyback by a still-independent Rackspace may be more likely than a sale. He wrote:

Analyst Gray Powell of Wells Fargo, who has been a pretty smart observer of the ebb and flow of Rackspace rumors, suggested in a research note on Aug. 25 that Rackspace could keep its shareholders happy with a share buyback worth as much as $1 billion by the end of 2015. And [Rackspace CEO Graham Weston] has started making comments on earnings calls suggesting that he’s warming to the idea. At that size, a buyback could take as much as 22 percent of Rackspace’s shares off the table.