Dell Clears The Decks To Buy Rackspace

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Dell (NASDAQ: DELL) has given up on its own OpenStack cloud and says it will now re-sell cloud services based on partners' software. 

At the same time, its buyout proposal seems stalled. The company is working through a competing proposal from Carl Icahn. The committee running the auction is now asking Icahn for information, in a move that sounds like stalling for time.

But that doesn't make much sense, given that uncertainty surrounding the buyout has helped create a profit implosion.  For the quarter ending May 5 Dell earned just $226 million on sales of $14 billion, its losses in PCs partly offset by a gain in “enterprise solutions and services” of 12%.

All these moving parts should point speculators to an obvious solution.

Buy Rackspace (NYSE: RAX).

The Case for Rackspace

Rackspace is the largest host of OpenStack services, it has more contributors to the open source cloud infrastructure than anyone else. And it's located just down I-35 from Dell, in San Antonio. When the highway is jammed, there's a new toll road alternative.

Best of all, Rackspace is a relative bargain. The stock price fell off a proverbial cliff after a bad quarterly report for December, and things haven't gotten any better. Top-line growth has stalled, and the bottom line has nosed downward. Debt levels, on the other hand, are down significantly.

Isn't this a huge risk for Dell? Isn't OpenStack dying for the same reason Dell abandoned it, price pressure from Amazon.Com and its Amazon Web Services offering? Isn't this an impossible place in which to make a buck, given that Google  and Microsoft have both committed to matching Amazon's low, low prices?

Maybe. But Rackspace isn't alone on the OpenStack train. Hewlett-Packard remains committed to the technology. So does IBM.

And the fact is, the global race toward cloud has only just begun. Most of Amazon's capacity is in a single data center, located in Virginia. The next step in cloud will be the creation of multiple, redundant data centers, spread around the world, something Google already uses for its own services.

Many companies in other countries have also been reluctant to commit to cloud because of local laws. Switzerland, for instance, demands that data about Swiss citizens stay in Switzerland. Other countries have similar laws. Clouds that can do governance barely exist yet.

These clouds are far more likely to emerge on OpenStack than on any other cloud infrastructure. IBM is committed to solving this problem. Its solutions will go into the commons. Rackspace has access to that commons.

Dell's latest move doesn't mean it's abandoning cloud. It means, for the present, it's looking at others to sell access to its clouds, which will be based around the world, in order to avoid the problem caused by Amazon's low, low prices.

Your Downside Looks Protected

And even if Dell doesn't buy Rackspace, even if Rackspace continues to falter, someone else will. HP might. IBM might.

In other words, you have downside protection on your Rackspace investment. Dell's recent gains mean it can do an all-stock deal for Rackspace that gives it two-thirds of the resulting company, a controlling interest. HP, believe it or not, could still buy Rackspace for cash.

Rackspace, in short, is in play, if not in fact then in a virtual sense. In a cloud sense.


Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool recommends Rackspace Hosting. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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