San Antonio Express-News (Sunday)
Besides mounting losses, what’s holding down Rackspace stock?
It’s hard to overstate the importance Rackspace Technology Inc. played in San Antonio’s imagination about itself in 2009, the year I arrived in town.
As a scrappy midsize technology company, launched by three college students in a dorm room, it established an early-mover advantage in cloud hosting — a growing area in technology services — and used that advantage to compete with the biggest names in tech, including Amazon, Microsoft and Google. Hopefuls wondered whether Rackspace, with its mantra of providing “fanatical support,” could do for San Antonio what Dell did for Austin. Could the ambitious company and its employees, known as Rackers, outdo the stiff competition and transform the sleepy Alamo City into a tech hub?
More than a decade later, the relentless drop in Rackspace’s stock price from $20 per share two years ago to just over $1 as of this writing tells us that David did not slay Goliath. The stock’s chart over the past two years is a Matterhorn-shaped downward slope with no bottom in sight.
Rackspace’s market capitalization dropped during that period from $4 billion to about $250 million by mid-May, approaching one-twentieth of its former size. Looking at that kind of chart, I can’t help asking: “Is Rackspace dead?”
And beyond that, there’s a technical question: “What the heck is wrong with Rackspace’s shares?”
I want to distinguish between a company and its shares. A good company can be a bad stock investment, while in certain instances, a bad company can be a good stock investment — and everything in between. I will mostly reserve judgment for a future column on whether Rackspace, whose stock is traded under the symbol RXT, is a good company with positive long-term prospects.
Here, I’ll mostly discuss some specific technical issues that may have plagued RXT stock during the past two years — the past few months in particular — as well as a technical change in stock market plumbing announced last week that reflects RXT’s changed prospects.
Numbers of note
But before I get to that, let’s take note of some fundamental metrics.
Rackspace reported a loss of $612 million on $759 million of revenue in the first three months of 2023, following a loss of $805 million on $3.1 billion in revenue for the year 2022.
As of March, the company reports $3.3 billion in long-term debt at an average interest rate of 5.5 percent, not due until 2028, giving it attractively priced debt service and a fiveyear runway before it needs to refinance the debt.
Cloud computing services, as an industry, are projected to grow 15 to 20 percent annually for the next five years, so an
experienced provider that merely maintains market share with the industry’s natural tailwinds could be positioned to grow nicely.
Fundamentally, we have five years to find out whether Rackspace is dead.
Stock market forces
So what technical forces have been crushing RXT, the stock, these past two years?
Technical analysis seeks to explain the current and future price movements of a stock according to the supply-anddemand dynamics specific to the stock. This is distinct from studying the business’s financial metrics — revenue, cost, debt and cash flow — as we did above.
Private equity firm Apollo Global Management remains the largest holder of RXT with 61 percent of the company’s shares. In 2016, Apollo took the company, then called Rackspace Hosting with the stock symbol RAX, private from the New York Stock Exchange. Apollo then relaunched Rackspace in a second initial public offering of stock under the ticker RXT in August 2020 on
the tech-oriented Nasdaq Stock Market.
In part, because Apollo still owns most shares, the supply of tradable shares — or “float” — is quite small, and very few individual — or “retail” — investors own shares.
The volume of share transactions in RXT has declined over the past year, along with the stock price. A year ago, $5 million to $8 million of shares traded hands per day. That has slowed over the past two months to an average of less than $2 million per day.
A low float of the shares, the declining dollar amount of trading, and a price approaching $1 per share all tend to further depress interest in a stock among professional investors.
Non-Apollo shares are mostly owned by small capitalization index mutual funds. I strongly believe that this is the key to understanding RXT’s one-way price movement over the past months.
The top mutual fund holders of RXT are exchange-traded funds and index funds, including Vanguard, iShares Russell and Fidelity. RXT
shares are also held in some “technology” and “total market” index funds.
For RXT, a major technical problem resulting from such ownership is that each of these indexes is “market-weighted.” This means that as a company’s market capitalization drops, the automatic weighting of it within that index drops. That makes the indexes forced sellers of the company’s shares as prices decline in a vicious, self-reinforcing cycle.
In theory, and as often happens with other stocks, institutional value — non-index — investors sometimes jump in to buy shares in this scenario, which helps to break the cycle. But for most value investors, RXT’s float is too small, the trading volume is too small, and most importantly, value investors don’t love annual losses larger than a company’s market capitalization. So far, they’ve stayed away.
A new obstacle
I suspect the biggest problem facing RXT is a change that occurred this month in the specifics of the Russell 2000 index, which determines ownership of small capitalization index funds.
The Russell 2000 index consists of small-capitalization U.S. companies, in particular those ranked 1,000 through 3,000 on the list of U.S. companies, by size.
As of 2022, the smallest Russell 2000 index company — ranked 3,000th on the list — had a total market cap of $240.1 million. Interestingly, RXT dipped beneath that bottom floor this month.
The Russell 2000 index makers set April 28 as the annual cut-off date for determining who is in or out of the index. On that date, RXT had an approximate market capitalization of $320 million, putting RXT on the bubble of being dropped by the Russell 2000 Index. The result of that would be further forced selling by the
index holders.
New IPOs enable companies to be added quarterly. Other additions or subtractions due to growth, mergers or shrinkage occur just once a year. Companies are subtracted from the Russell 2000 index on an annual basis, and May 19 was the announcement date for whether RXT would remain in the index.
Although RXT was on the bubble, it remained in the Russell 2000, as the size of the smallest company to remain dropped to $159.5 million in 2023, 33 percent below the previous floor.
On May 19, RXT actually got added for the first time to the Russell Microcap Index, the index for even smaller companies with market capitalizations as low as $30 million.
But even though RXT was not removed from the Russell 2000 list this year, the risk of subtraction from the index and the vicious cycle of lower prices leading to lower market weighting could explain much of the past few months’ price action in RXT.
Getting put on the Russell Microcap Index is somewhat analogous to relegation from triple-A baseball to a single-A. The stock may take a long time to attract major league investors, or it may never again attract them.
Languishing in obscurity is OK for profitable companies that can put together a good fundamental track record of profit over time. It could get back on the list and in that sense be eligible again for the majors. For a company with $3 billion in debt due in five years and a string of annual losses, it may be a harder slog.
Time will tell.