Rackable-SGI Deal Will Create Stronger Company, CEO Says

In former Silicon Valley superstar SGI, Mark Barrenechea, president and CEO of Rackable Systems, sees a company that is a solid fit for his own.

Rackable announced April 1 that it is buying SGI—formerly known as Silicon Graphics Inc.—for $25 million, a pittance for a company that itself once sold massive computing systems for millions of dollars.

However, after years of being unable to adapt quickly enough to the changing technology landscape, SGI is now shutting down for good, with its products and employees being folded into Rackable, which makes industry-standard servers and storage systems for midsize and enterprise compute environments.

The sale of SGI is the latest move in a market that seems ready for some consolidation. Most notably have been the rumors that IBM is negotiating to buy Sun Microsystems, another tech stalwart that has been struggling for several years. Neither IBM nor Sun have confirmed the talks.

During a brief conference call with investors, analysts and reporters later in the day April 1, Barrenechea said Rackable, with SGI, will be a larger player in the HPC (high-performance computing) business, will be able innovate even more in such areas as power, cooling and visualization, and will be a player in the growing field of shared storage.

“This is a strategic fit with limited product and marketing overlap,” he said. “Relevant innovation is at the heart of this proposed deal.”

For example, Barrenechea said that, according to numbers from research firm IDC, the HPC market will grow to $11 billion in 2012. Rackable should be a strong player in that space, thanks to SGI, he said. SGI a year ago bought Linux Networks, in large part to help it grow its HPC business.

He also noted that, combined, the two companies spent $70 million in R&D, showing a tradition of innovation that he expects to continue. Barrenechea said 2009 will be “a year of integration and innovation.”

He said there may be some overlap with SGI’s low-end systems in the cluster computing space, but not much beyond that.

Rackable’s systems, through a unique back-to-back design, are aimed at helping businesses increase the density of their data centers while reducing power consumption and improving cooling and management capabilities.

Clay Ryder, an analyst with The Sageza Group, said that some in the industry may look at the sale of SGI to 10-year-old Rackable as the fall of a technology titan. In reality, though, SGI had simply run its course.

“SGI really didn’t have the strength to continue as an independent entity, and the industry said so,” as illustrated by the multiple bankruptcies and slowing sales, Ryder said.

The deal with Rackable is a good one for SGI customers, who can expect to see some level of support for their SGI customers, as well as resellers, who will still have some SGI products to offer, he said.

“What really matters to customers is that their products are supported, and for them, it really doesn’t matter what nameplate is in there,” Ryder said.

The benefits for Rackable are less clear, he said. At $25 million, there aren’t a lot of risks for Rackable.

“It’s a relatively low price for Rackable to pay to get some products, some engineers,” Ryder said. “It may give Rackable some products they can use.”

The deal for SGI follows through with a pledge Barrenechea made in February, when Rackable announced its fourth-quarter earnings, to spend 10 percent of its cash reserves to expand its product offerings and sales. According to Rackable’s earnings report, it had $181 million in cash after the fourth quarter.

However, Rackable is taking on a company that has struggled mightily in recent years. SGI, which was entering its 26^th year this year, made a lot of money selling high-end, expensive and proprietary servers and workstation for tasks that called for 3-D, video and animation capabilities. However, the company—which once owned the sprawling Mountain View, Calif., campus that now houses Google—struggled as the market turned to smaller and cheaper industry-standard systems powered by chips from Advanced Micro Devices and Intel, and SGI could never catch up.

In 2005, the company was delisted from the New York Stock Exchange, and a year later emerged from five months of Chapter 11 bankruptcy protection. Part of the plan was shelving its legacy MIPS/Irix hardware, focusing instead on building systems using Intel chips, as well as building out it visualization and shared-storage technologies. SGI initially focused on using Intel's Itanium chip, which has been hobbled by low interest and product delays. That was changing, however. On March 30, SGI announced that its Altix ICE integrated blade platform would be powered by Intel’s new Xeon 5500 series processors.

However, a few weeks ago, SGI, which has about 1,200 employees, learned that it again would be delisted from the NYSE, and on April 1 filed for bankruptcy a second time. In the Chapter 11 paperwork filed in New York, SGI listed assets of $390 million and debts of $526 million. The company cited its cost structures, decreasing revenue and growing competition as the key issues behind the bankruptcy filing.

Rackable officials declined to talk about specifics regarding the liabilities it will take on by buying SGI. Chief Financial Officer Jim Wheat would only say that Rackable officials had “analyzed this and we do have enough cash to continue the operation of a combined business.”

Rackable in the fourth quarter of 2008 generated $38.8 million, a significant drop from the $111.3 million in revenue it had in the fourth quarter of 2007. Officials said much of that decline was attributable to its two largest customers—which account for 21 percent of Rackable sales—reducing their purchases. Officials said they entered 2009 with $20 million in backlog orders and deferred payments.

In January, Rackable announced it was cutting its work force by 15 percent. When announcing the deal for SGI, officials also said they were suspending a planned $40 million stock buyback plan.