Rackspace IPO needed to cope with fast growth

Fifteen million shares of hosting provider Rackspace Hosting began trading under the symbol "RAX" on the New York Stock Exchange Friday for US$12.50 a share.

Rackspace, which provides IT systems and computing as a service to more than 33,000 customers worldwide, said Friday it is selling 12.7 million shares of common stock, with selling stockholders offering an additional 2.3 million more. Underwriters also have an option to purchase an additional 2.25 million shares to cover over allotments, the company said.

Rackspace's offerings include managed hosting, e-mail hosting, cloud hosting and platform hosting. The company filed its prospectus with the U.S. Securities and Exchange Commission to offer an IPO (initial public offering) in April.

In the prospectus, the company said its goals for the IPO are to grow its hosting efforts around the world, particularly by expanding into markets in Europe and Asia. Rackspace also will continue its focus on both "aggressively" acquiring new customers as well as retaining existing ones, and will add services and employees to meet customers' growing needs.

Rackspace cited inability to manage company growth effectively as a risk factor going forward in its filing, noting that it has more than doubled its number of full-time employees from 730 at the end of 2005 to 2,021 at the end of 2007 while growing revenue from $138 million to $362 million in that same period.

This rapid growth "has strained our operating and financial resources," the company wrote.

Also, Rackspace has purchased a 1.2 million square-foot data center in San Antonio, Texas, to house corporate operations and potentially add data-center facilities, and also plans to expand operations internationally. These expenses must be managed carefully by the company to ensure growth, it said.

A downside of expansion is if Rackspace overestimates the data-center capacity it will need to serve customers in the future. The company estimates demand for its services about two years ahead of time and plans its data-center capacity accordingly, it said in the SEC filing.

"If we overestimate the demand for our services and therefore overbuild our data center capacity, our operating margins could be materially reduced, which would materially impair our profitability," according to the filing.

Rackspace had revenues of $362 million and profits of $17.8 million in 2007, it said in its prospectus. Cash flow from operations was $105 million for the year.

IPOs in the technology industry have been scarce lately. However, the market for providing hosted services -- increasing becoming known as offering applications "in the cloud" -- has been growing as large vendors such as Google and Microsoft are bucking the trend.

Research firm IDC predicts the U.S. market for Web hosting services will increase about 10 percent in the next several years, from US$9 billion in 2007 to $14.6 billion in 2012. The firm puts Rackspace in the category of pureplay managed hosting services provider that focuses primarily on midmarket and low-end enterprise hosting space, according to a research report by analyst Melanie Posey.

Joint book-running managers for the IPO are Goldman, Sachs & Co., Credit Suisse Securities and Merrill Lynch & Co. W.R. Hambrecht + Co., Jefferies & Company, Cowen and Company, RBC Capital Markets, JMP Securities, Signal Hill Capital Group, and E*TRADE Securities are the co-managers for the offering.

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