Rackspace will experience more margin expansion as it resorts to debt to fund share buybacks
In the prior part of the series, we discussed Rackspace’s (RAX) fiscal 2Q15 earnings. Its revenue growth failed to meet analysts’ expectations, but the company did meet analysts’ expectations on the EPS front. Thus, investors may be wondering why its shares were up by ~5% on August 10, 2015. The reason for this was the company’s announcement of a $1 billion stock buyback, of which $500 million is expected to be completed in the coming six to nine months.
As the presentation above shows, the trend of bond/debt issuance has moved in sync with the share buybacks in the US in the past. According to the BIS Quarterly Review from March 2015, share buyback booms in the US have usually coincided with the increase in net bond issuance, implying that the buybacks have been financed at least partially by debt or bonds.
IT firms like Apple (AAPL), IBM (IBM), Cisco (CSCO), Oracle (ORCL), and Microsoft (MSFT) accounted for around 30% of the entire share repurchases in the United States. Rackspace seems to be following its technology peers in this regard.
Another reason these leading technology players have to resort to debt to fund dividends and share repurchases is the majority of their cash is parked outside the US, as we have discussed in the prior part of the series. According to a Bloomberg report published in March 2015, Microsoft, Apple (AAPL), Google (GOOG), and five other technology firms account for more than 20% of “the $2.1 trillion in profits that US companies are holding outside the US.”
You could consider investing in the iShares US Technology ETF (IYW) to gain exposure to Rackspace. IYW invests about 0.11% of its holdings in Rackspace.