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Rackspace sued for failing to disclose Vodafone contract loss

May 30, 2017 GMT

Rackspace Hosting has been hit with a securities class action lawsuit from a pension fund that claims the company “intentionally concealed the impending loss” of a contract and the impact it would have on the company’s growth.

The City of Warwick Municipal Employees Pension Fund filed earlier this month a securities class action lawsuit against Rackspace and two former executives for failing to disclose the loss of a major contract.

Rackspace is accused of making “false and misleading statements” regarding its contract with British telecom company Vodafone Group, according to the complaint filed in the U.S. District Court for the Southern District of New York. The fund believes “there are hundreds of thousands of members in the proposed Class,” which runs from Nov. 11, 2014, to Aug. 10, 2015, according to the complaint.

Vodafone contracted with Rackspace to host and support its M-PESA money transfer and payment system platform. Rackspace knew the contract was coming to an end in 2015, the complaint says, but executives were still upbeat in comments with investors about the company’s growth prospects.

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“By the start of the Class Period, unbeknownst to investors, Rackspace and Vodafone were in discussions concerning the non-renewal of the Vodafone Contract,” the complaint alleges. “In fact, Vodafone had engaged in extensive data-migration away from Rackspace servers well in advance of the April 1, 2015 expiration date, signaling Vodafone’s intent to replace the Rackspace contract with alternative providers.”

The complaint alleges that stock prices fell once people found out about the lost business.

“In response to the loss of the Vodfone Contract, the price of Rackspace shares stock declined over the next two trading days — falling from $53.13 per share on May 11, 2015 to close at $43.75 per share on May 13, 2015, or 17.65 percent, on extremely heavy trading volume. This two-day drop wiped out more than $1.3 billion of the Company’s market capitalization,” according to the complaint.

Attorneys for the pension fund at Labaton Sucharow declined to comment. A Rackspace spokesperson said via email that the company’s policy is to not comment on pending litigation.

In addition to Rackspace, the fund also names in the suit then-CEO Taylor Rhodes, and then-Chief Financial Officer Karl Pichler. Pichler’s last day as CFO for Rackspace was May 23, according to a spokesperson.

Rackspace announced in August that it was being acquired by New York private equity firm Apollo Global Management in a deal valued at $4.3 billion. About six months after that sale, Rhodes said he was leaving the company.

If the complaint’s allegations are true, a judge or jury could find a securities law violation in this case, Neal Newman, a law professor at Texas A&M University School of Law, said via email. Newman specializes in securities and transactional law.

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“What’s not outlined in the complaint and might be helpful in the analysis would be comparing the revenue that Rackspace was receiving for the Vodafone contract versus TOTAL revenue that Rackspace was receiving for all of business lines for that segment,” he added.

That would help determine how crucial Rackspace’s work with Vodafone was to its business, Newman said.

The legal question, too, is whether the information Rackspace supposedly withheld is considered material, meaning that it’s “information that might affect a reasonable investor’s decision to purchase or sell the stock,” Newman said.

“But on balance, based on what is alleged in the complaint, the omission appears to be a material one and something Rackspace should have disclosed back in 2014 where it appears they first became aware of Vodafone’s intent not to renew the contract,” Newman said.

While Ramona Lampley, a professor of law at St. Mary’s University School of Law, wouldn’t comment on the case, she agreed that the revenue on the Vodafone contract would be a helpful factor in analyzing whether it has any merit.

“Reading the complaint, I can’t even begin to imagine whether this is material or not,” she said. “It would be very difficult to assess at this point and time, at the beginning of the case.”

Lampley emphasized too that Rackspace still has to respond — and that there are two sides to every story.

Rackspace executives said Vodafone was one of the company’s largest customers.

“It’s one of our largest customers in the Company and the largest one in our UK business,” Pichler had said in 2015 during the Cowen and Company 43rd Annual Technology, Media & Telecom Conference, according to a transcript of the conversation on Rackspace’s website. The event was after Rackspace had disclosed to investors that Vodafone was migrating some of its data.

Rackspace had some “churn” events with Vodafone in the past, Pichler said during the conversation, but that overall the relationship “has been a net positive grower.”

“So in this specific case we have been — known about this,” he said, according to the transcript. “We have been talking about this.”

In its 2015 first quarter earnings call, Rhodes said the company “had a one-time revenue headwind in the second quarter, resulting from a unique circumstance,” according to an edited transcript on Rackspace’s website.

“For data sovereignty reasons, one of our largest and longest-tenured customers was forced to move their production element of a large environment from our data center in the UK, to a location in Africa, where Rackspace does not have a data center. This results in a one-time revenue reduction at the beginning of the second quarter. We retain all other environments, and a healthy relationship with this customer, and expect to grow this revenue back with them over time,” Rhodes said at the time.

Later on the call, Rhodes said, “the reason we decided to mention it — and we’ve never done it before — is it is material, and it is significant.”

But Rackspace declined to disclose the size of the impact of Vodafone’s lost business, according to the transcript. To be sure, Rhodes does not name Vodafone specifically during the call, but the complaint attributes this conversation to one about the contract with the company.

“We have customer agreements in place, things like that,” Rhodes said at the time. “So we’re not going to disclose the amount.”

Other law firms have also put out news releases notifying people that a class action against Rackspace has been filed. None of them immediately responded to requests for comment.

The law firms, Lampley said, are “trying to find the best entity, or person, but more likely an investment entity, to be the lead plaintiff so they have a good chance of being named as the lead law firm.”

“They want to be the lead law firm because they want to be able to negotiate the settlement and accrue the lion’s share of attorney’s fees,” she said.

The case will likely end in a settlement, because statistically, most of these types of cases end in some kind of settlement, she said.

“If I were a betting person, I’d put my money on settlement. These cases almost always settle,” she said. “Now this doesn’t mean Rackspace did something wrong or didn’t, or that there’s a viable case or not, it’s just that class actions, whether they’re securities class actions or not, they tend to settle.”

sehlinger@express-news.netTwitter: @samehlinger