One Startup’s Long Road To A Rackspace Acquisition And Dramatic IPO

By on November 20, 2013

patmatthews-rackspace

Pat Matthews

The big day came in 2005, in a nondescript IHOP in San Antonio over egg whites and coffee. Webmail.us CEO Pat Matthews was meeting with Pat Condon, the co-founder of Rackspace, near the company’s headquarters.

Matthews was telling Condon about Webmail’s new round of funding and how well the business was doing. “He said to me, ‘I think you should talk to Rackspace before you raise money.’ That confirmed an ongoing feeling I had for some time—they might be interested in acquiring us.”

The conversation resulted months later in Rackspace’s first major acquisition–Webmail.us. The 60-person company from Blacksburg, Virginia became a key part of Rackspace’s growth and later its corporate development strategy. Matthews’ story is a one of startup pivots, near shut-downs, a dramatic acquisition, and an emotional IPO as part of Rackspace, but ultimately a positive ending.

Matthews, a native of Springfield, Virginia, attended Virginia Tech during the exciting boom dot-com years. He and his cofounders, Bill Boebel and Kevin Minnick, got close to graduating. But like others at the time, they were swept up in the Internet boom and dropped out in 1999 to pursue a startup idea that Boebel had thought up while still in school and interviewing for corporate jobs.

The trio built fieldParty.com, a portal for local events with user-generated content, where people could find information on what’s happening in their cities, or list information they wanted others to find out about. (The idea was wildly different than what the company would later become.) They launched it on March 10, 2000.

Though they didn’t know it at the time, that day was the absolute peak of the Nasdaq at 5,408.60, which was more than double the index’s peak in the prior year. One month later the market was collapsing. The user generated content idea had not truly caught on yet, as this was way before the Web 2.0 craze. “It just wasn’t a perfect idea. It was the wrong idea at the wrong time.”

By the end of 2000, the team had pivoted to another concept, a content management system for newspapers and content providers. They used much of what they’d built for consumers and turned it into a tool for newspapers.“We turned that into a content management system and sold it to newspapers. Newspapers have content but they suck at technology. The idea was to sell it to newspapers and help them create an online presence.”

The summer before 9/11 was challenging. The company got about 30 newspapers signed up, but it didn’t take off.  “Newspapers didn’t want to be saved by these young dot-com guys,” Matthews says. “Every meeting was painful. We were now 1.5 years in, riddled with credit card debt, no degrees, and lots of self doubt.  We never really did formal layoffs but we had employees coming and going because we just couldn’t pay anyone at that time.”

Meanwhile, they were running short on cash. They ran up $100,000 in credit card debt. “We didn’t have early funding. We had friends and friends of friends. They’d invest $5,000 or $10,000 each. We got $100,000 (in funding) over 3 years.” During this period, Matthews at this time was selling books door to door to bring in some income. Then 9/11 hit, which brought another dark cloud in the economy.

FROM EVENTS TO EMAIL

Matthews and his team started to realize that there might be another business hidden in front of them. The company had always given away “@fieldparty.com” email accounts for free. Then when the company moved to the product for newspapers, it allowed newspapers to give away free email accounts to their customers.

In late 2001, and early 2002, the team also started to get demand just for hosted email service. The company, an early adopter of pay per click advertising and search engine marketing, also figured out how to increase that demand. “People were finding us on the Web and saying to us, ‘Can you just host our email?’ Once we realized we had something there, we ditched everything, got laser focused and became an email hosting company.”

The business, later known as Webmail.us, started to take off, and it was growing more than 100% per year. The company started as a pure consumer web company but ended up as a SaaS business for enterprises. While that may seem like a big change, it was all connected. “Email was the thread that tied it all together,” Matthews says. “We gave every fieldParty user a free email account. We allowed newspapers to give away free email and that’s what we ended up specializing in: email.”

In 2004, Webmail.us started to scale and needed to find a reliable hosting provider. But the team had used a number of providers without any success. So they decided to meet with Rackspace, which they had heard good things about. “We loved them. They got it. They’re very responsive and the ‘Fanatical Support’ is a real thing.”

Webmail.us started with five Rackspace servers and over the course of three or four years became Rackspace’s largest customer at the time. “We were such a high growth company that we got to know our account team, the executives, and even the founders.”

Meanwhile, in 2005, Webmail.us raised a small Series A of $500,000. Pat Condon, the co-founder of Rackspace participated in the round.

ACQUISITION TALKS

Over the years companies had called and expressed interest in buying Webmail, but nothing serious ever happened. Most were just fishing.

In 2007 Webmail was putting together a $3 million venture round. Matthews was talking to existing investors and was hopeful that he could get the funding done. Webmail was still growing fast and had hit a $10 million revenue run rate.

Meanwhile, Matthews was traveling from Webmail’s headquarters in Blacksburg, VA to San Antonio regularly to meet with Rackspace. The teams met regularly for lunch and dinner and became close. “We felt Rackspace was serious about doing an IPO. They were also thinking about moving into other product lines.”

Rackspace was interested in talking to Matthews about an acquisition as a way to move into adjacent product lines. And since Rackspace was clearly on a path to an IPO, the timing could work out, Matthews thought. After all, in 2007, the economy was heating up (though that would change quickly). “They became very serious about an acquisition. I was intrigued because as a partner, they’re top notch. The people were great. I knew a ton of the people there.”

When it came time to talk terms, Rackspace wanted to do an all-stock deal. Of course this could be very good for Webmail if Rackspace’s IPO had done well, or not so good if it tanked.

Rackspace had never done an acquisition before and both companies were private. So the trick with doing a sale for private shares was how to value both companies. Matthews says Rackspace agreed to provide him as much information as he needed to assess its value. Rackspace connected Matthews to its  bankers, who had 100-page documents with comprehensive analysis of what Rackspace would look like as a public company. Rackspace officials told Matthews: “Look, you tell me what you think you’re worth and what you think we’re worth. Talk to any of them and see what you think.” That’s what Matthews did.

Rackspace was smart, Matthews says, because they knew his team saw the deal as “a life changing moment.” Matthews and his partners talked a long time about the deal and pricing. Matthews says: “We felt that a $20 million dollar valuation was fair, especially since we felt there was upside and as importantly, we felt Rackspace would be a great place to work.  We told them, we think you’re worth $2 billion as a public company. So we’d be interested in selling for 1% of your company.”

“We really believed in the future of Rackspace. We had this belief that if we sold to them and went to work for Rackspace that whatever deal we could get now would be worth a lot more in the future. I thought it’d be a unique window–which turned out to be right. Remember in 2007 there were no Snapchats and Pinterests.  The closest thing I can remember was Flickr selling to Yahoo for $30 million. Times were very different.”

Convinced, the team moved ahead with the deal. “We built a real company so I’m proud of that. We had 60 employees and real salaries. We weren’t trying to flip it and we felt that Rackspace would be a good place to keep growing.”

On October 1, 2007, Rackspace and Webmail announced the deal. Then things really got interesting. In 2008 Rackspace moved on a path to an IPO.

PUBLIC MARKET UPS AND DOWNS

Leading up to the IPO in 2008, the market was falling apart. Already, 12 IPOs had been pulled that year before Rackspace. There was some concern that Rackspace would not get its IPO out to the market. “It was a scary moment. Everything started unraveling especially as we were doing our roadshow.”

The stock finally began trading on August 8, 2008. Matthews was watching from his office in Blacksburg, VA. The IPO had a number of things going for it. Rackspace was growing fast and had solid financials as well as top venture investors including Sequoia Capital and Norwest Venture Partners. The bankers were Goldman Sachs, Credit Suisse and Merrill Lynch.

But the broader economy was already falling apart and taking IPOs down with it. “It was a day filled with a mix of pride and anxiety. We were proud to be a part of such a successful company but you could feel the markets falling apart and we were certainly punished for that.”

The company had previously lowered its price target on the offering to $12 to $16 as demand slipped. Rackspace raised $187.5 million in the IPO, but shares priced at the lower end of the range at $12.50 a share. Shares then dropped on the first day of trading and closed down 20%.

A month later on September 15, 2008, Lehman Brothers imploded and the entire market tanked. Rackspace eventually dropped as low as $4 per share, about 20% to 25% of what Matthews and company had estimated. “We ended up trading at less than our revenue. It was really awful. From $4, we hunkered down and said let’s not worry about the share price.”

POST-ACQUISITION INTEGRATION

In the first two years after the acquisition Rackspace acted like a venture investor for Webmail. “They just gave us people and money to grow the business,” Matthew says. “I was the CEO of a business owned by Rackspace. We didn’t even change our name. We were still in Virginia.”

Since his business was doing well, Matthews was recognized an up-and-coming leader. So he was tapped to head the growing cloud business for Rackspace. Matthews managed massive growth in that business. But the growth was a bit messy. “There was crazy growth like nothing I’d ever seen.”

Moving into 2012, as the cloud business began to reach a level of maturity, Rackspace started to integrate it into the core business. While Matthews was figuring out what to do, he was offered the job to run Rackspace’s corporate development. In the role he met with startups and eventually acquired three companies and made four investments.

The fact that Matthews had gone through the process already made it easier for him to move things through Rackspace. Essentially, Webmail became a model for how to do post-merger integration within Rackspace. “The fact that I’d been at Rackspace a long time gave me credibility with skeptical entrepreneurs.”

REFLECTIONS

Matthews and his team had two failed concepts before they found a successful one in Webmail.us. “We were failures for two years and didn’t feel successful for a long time after that. Luckily we were able to realize our ideas were wrong and pivot accordingly,” he says.

Matthews, who never took a break after co-founding fieldParty.com in 1999, has recently decided to leave Rackspace and take some time off. “I never took a break. We built a company out of nothing and ultimately became executives at a multi-billion dollar company. And while I had the time of my life at Rackspace, I don’t quite fit the mold of a professional executive. I gave my all to Rackspace for more than six years and I am proud of that.”

He says one of the most important things to him is keeping the relationships he built through the years both at Webmail and Rackspace. “Every time I give a talk on my experiences people seem to be most befuddled by the fact that I’m still best friends with my two co-founders. Relationships and loyalty are really important to me. We managed through some really tough times together but we fought through it all—together.  We didn’t quite build the next Twitter but I am proud of what we did build and we didn’t have to step on each other to do it.”

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2 thoughts on “One Startup’s Long Road To A Rackspace Acquisition And Dramatic IPO

  1. Doug Wood says:

    A great story and a rare win-win in the M&A world. Taking a start-up from good ideas to acquisition is not for the faint of heart, and the Webmail.us team did an excellent job. Kudos also to Rackspace for a high value strike.

  2. tweeksva says:

    Pat’s a great guy and has done a lot of great things. Rackspace was luck to have him. Glad to see him taking it easy finally. 🙂

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