Talking Deal Prices: Rackspace going private with 4x EBITDA of leverage

While take-privates remain relatively rare among buyouts, the practice of acquiring a publicly traded company for a premium over its trading price seems to have gotten more popular during a choppier time in financial markets in 2016.

Whether the January-February credit crunch or the Brexit hiccup over the summer, stocks have been shaken more dramatically than in recent years.

Out-of-favor stocks have been hit harder by the volatility and have been much slower to recover. That dynamic has created a more favorable environment for GPs to spot value and swoop in.

In the third quarter, sponsors closed at least 19 take-privates, a pretty good haul for the deal type compared to most recent periods.

The LBOs ranged from the blockbuster $10.3 billion acquisition of Chinese internet security company Qihoo 360 by a consortium of investors including Sequoia Capital, down to the tiny $21 million take-private of Yoho Resources Inc by One Stone Energy Partners LP.

Other GPs swimming in the take-private pool included Advent International, Kline Hill Partners, Leonard Green & Partners, Platinum Equity, Providence Equity Partners, Siris Capital Group, Thoma Bravo and Vista Equity.

Bargain-hunting Apollo Global Management closed two take-privates in the third quarter, including a $3 billion deal for vacation provider Diamond Resorts International and the $1.45 billion acquisition of Outerwall Inc, an operator of Redbox movie- and videogame-rental kiosks.

Late in the quarter, Apollo also said it planned to team up with Searchlight Capital to buy Rackspace Inc, a provider of cloud computing services, for $4.4 billion. The $32-a-share all-cash deal is expected to close in the fourth quarter.

While the purchase price amounts to a premium of 38 percent over the stock’s trading level prior to acquisition rumors in early August, it’s much lower compared to past years. In 2015, the Rackspace stock peaked in the low $50s and then steadily gave up ground to below $25 a share this year.

Leon Black’s Apollo is buying Rackspace for about 6x its estimated 2017 EBITDA of $730 million, according to estimates from Thomson Reuters. That’s a pretty low multiple compared with the double-digit purchase prices for most private companies nowadays.

Total leverage comes to about 4x EBITDA when the deal closes. While Fitch Ratings in a recent note called the debt level “elevated,” it’s still lower than the average leverage level of 5.13x EBITDA in private buyouts, according to estimates from LCD, a unit of S&P Global Market Intelligence. Moreover, Fitch expects the company’s debt level to fall to about 3.5x EBITDA over the next 12 to 18 months as it uses free cash flow to pay down debt.

To fund the deal, Apollo and Searchlight proposed $3.2 billion of funded debt and $1.3 billion of new equity. Putting together the capital stack for the deal, Rackspace will issue $2 billion in a senior secured Term Loan B and a $225 million senior secured revolving credit facility, which will be undrawn at closing, plus $1.2 billion of senior unsecured notes.

Rackspace CEO Graham Weston said recently the company could go public again in the next five to seven years, according to a report.

Meanwhile, Apollo and Searchlight will control a company that faces big challenges from Amazon Web Services and Microsoft (Azure). But Rackspace plans to pivot away from competition around public cloud offerings toward expected growth in the managed cloud service business, Fitch said.

Deal prices fall again but not by much

Average purchase-price multiples for U.S. LBOs dipped a few basis points in the past year but still remain in lofty double-digit territory.

In the third quarter, the average buyout multiple fell to 10.94x EBITDA from 11.01x in the year-ago period, according to LCD.

While lower than the year-ago period, purchase-price multiples rose from 9.84x EBITDA in the second quarter, as deal-making picked up steam.

Rather than any sign of cooling, the price changes may suggest a leveling-off in LBO pricing. Weakness in some sectors may be letting air out of the M&A business right now, but activity, and prices, may head up once uncertainty around the U.S. election clears up and deal-makers look to wrap up a relatively busy 2016.

Action Item: See public equity benchmarks here, http://www.reuters.com/finance/markets/indices

Traders work on the floor of the New York Stock Exchange shortly after the opening bell in New York on October 12, 2016. Photo courtesy Reuters/Lucas Jackson