Rackable Systems Inc (NASDAQ:RACK) has announced that it is suspending its buyback and acquiring substantially all the assets of Silicon Graphics Inc (NASDAQ:SGIC) for “approximately $25 million in cash, subject to adjustment in certain circumstances, plus the assumption of certain liabilities associated with the acquired assets.” Without the buyback, our investment thesis is gone, so we’re exiting our position in RACK. We opened it on March 11, 2009 when it was trading at $3.56, so we’re up 9.0% on an absolute basis. The S&P500 Index was trading at 719.60 when we opened the position in RACK, and closed yesterday at 811.08, which means we’re down 3.7% on a relative basis.
We started following RACK (see our post archive here) because it was an undervalued asset play, and had announced a plan to repurchase almost 40% of its stock. That buyback is now suspended. If the buyback had been completed at the current stock price, the company’s per share liquidation value would have increased by around 17% to $6.72. The acquisition of SGIC’s assets is also almost certain to reduce RACK’s liquidation value. The likely reduction in liquidation value combined with the suspension of the buyback is fatal to our investment thesis, and that’s why we’ve exited. On the whole, a disappointing outcome for us, but the stock is up to $3.95 in after hours trading, so the market clearly disagrees with our assessment.
The Asset Purchase Agreement makes for interesting reading, and the deal may well turn out to be a good one for RACK. It’s certainly buying at the right time and from a distressed seller, which are indicators, but not conclusive, that the deal is good for RACK. It also seems from the Asset Purchase Agreement that RACK is cherry picking the assets it wants and avoiding the liabilities it doesn’t. Whether the deal works for RACK, we have no idea. This sort of analysis is beyond us, so we focus on the liquidation value. Prior to the company entering into the agreement with SGIC, we estimated the liquidation value at around $171.6M or $5.74 per share. Although it is difficult to predict with any precision the effect of the acquisition on RACK’s liquidation value, we are almost certain that it will be reduced by the $25M cash payment plus whatever liabilities are assumed less a smaller increase for the assets acquired. It is likely that RACK’s liquidation value will still be somewhat above its present stock price, but, without the buyback catalyst, our reason for holding the stock is gone, and so we’re out. There’s a chance that the deal will fall over, so we’ll revisit RACK in that event.
The company’s press release is set out below:
Rackable Systems Announces Agreement to Acquire Silicon Graphics Inc.
FREMONT, CA and SUNNYVALE, CA., April 1, 2009 – Rackable Systems, Inc. (NASDAQ:RACK), a leading provider of servers and storage products for medium to large-scale data centers, today announced its agreement to acquire substantially all the assets of Silicon Graphics, Inc. (SGI) (NASDAQ: SGIC) for approximately $25 million in cash, subject to adjustment in certain circumstances, plus the assumption of certain liabilities associated with the acquired assets.
The combined businesses will provide customers with market leading hardware and software technology within large-scale x86 cluster computing, HPC, Internet, Cloud Computing, large-scale data storage environments and visualization platforms across many verticals and geographies. This combination is also expected to result in a stronger global services organization; reaching commercial, government and scientific sectors on a worldwide basis.
“The combined company will be positioned to solve the most demanding business and technology challenges our customers confront today,” said Mark J. Barrenechea, president and CEO of Rackable Systems. “In addition, this combination gives us the potential for significant operational synergies, a strong balance sheet, and positions the combined company for long-term growth and profitability.”
“We have been working very hard to strengthen our company, and today, we’ve taken another big step in that direction,” stated Robert “Bo” Ewald, CEO of Silicon Graphics. “This transaction represents a compelling opportunity for Silicon Graphics’ customers, partners and employees, who can all benefit from the emerging stronger company with better technologies, products and markets reach.”
Barrenechea added, “Together, we believe we will be a much stronger entity with great products and people offering a compelling proposition to compete more effectively in, and across, our collective markets.”
Rackable has signed an Asset Purchase Agreement to acquire substantially all the assets of SGI, and to assume certain liabilities relating to the assets, pursuant to Chapter 11 of the U.S. Bankruptcy Code, under which SGI filed its petition in New York on April 1, 2009. Completion of the transaction is subject to a number of closing conditions, including the approval of the Bankruptcy Court, and other uncertainties. Subject to such conditions and uncertainties, the transaction is expected to close within approximately 60 days. It is expected that SGI’s business operations will continue during the pre-closing period. SGI’s international operations would be part of the sale, but would not be part of the bankruptcy process.
Rackable also announced today that it had suspended its previously announced program including the repurchase of up to $40 million of the company’s stock.
Hat tip to shp.
[Full Disclosure: We have a holding in RACK. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]