Apollo wagers $4.3 bln on Amazonian capitulation

August 26, 2016

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

Apollo and Searchlight Capital are making a $4.3 billion bet on capitulation. Apollo, the private-equity firm run by Leon Black, is leading a deal to take Rackspace private, after the cloud computing firm struggled to compete against Amazon, Microsoft and other tech giants. If Rackspace’s strategic shift to sell services on these platforms succeeds, Apollo will have a nice payday.

About 70 percent of Rackspace’s revenue comes from managing server farms for individual companies. That’s a stable but relatively low-growth business. The excitement has come from its public cloud operations, where it competes against Amazon Web Services and Microsoft’s Azure, selling on-demand computing and services.

The problem is this is a business of scale. Bigger firms can negotiate to buy servers and power at lower prices, and deploy gear more effectively. Giants Amazon and Microsoft can therefore offer better deals to customers without suffering a big hit to margins.

Rackspace is trying a bit of jujitsu. While it’s not abandoning its efforts, the company realizes it can’t effectively compete against Amazon and Microsoft. So it has become a partner, selling services and helping companies port their data and software to Amazon Web Services and Azure. There’s an additional benefit to Apollo. It takes a lot less capital to offer consulting services than to build and run server farms.

There is risk. While its existing business of managing server farms for individual businesses probably will provide enough cash flow to cover costs and service debt, success will rely on its new partnerships taking off. That may not happen. Customers may wonder whether it makes sense to pay for additional support and services, especially as Amazon and Microsoft continually make their web services easier to use. The growth of cloud computing, however, may mean there’s plenty of room on the Amazon and Microsoft bandwagons.

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