Tuesday, 11 February 2014

Rackspace - "(still) feeling lucky, punk"?

Back in late November/early December I wrote up some thoughts on the theme positive big data / cloud infrastructure company Rackspace and noted that:

'A stunning theme in big data and a company playing both direct premium services and the open source angles.  We also have a x50s P/e…and more price competition coming?...Competition, powerful structural themes and consolidation.  Investors need to feel lucky to be active here.  Get your timing right though and the rewards will be strong.  On that basis, below US$35 I am buying a few'. 

Rackspace's Q4/FY numbers came out yesterday after the US close.  What did they say? Well, as Seeking Alpha noted:

'Though Rackspace's (RAX) Q4 revenue growth (15.6% Y/Y) was nearly on par with a Q3 level of 15.7%, its gross margin fell 190 bps Y/Y to 67.2%, adjusted EBITDA margin dropped 440 bps to 32.4%, and op. margin fell 740 bps to 6.7%'.
Yes, the competition from companies such as Amazon and Google continue despite strong growth in public cloud revenues (which include the Rackspace-inspired OpenStack) and just about double digit growth in web hosting. 
The overall numbers were probably not particularly better or worse than the market was hoping for.  What was unexpected though was the announced retirement of the CEO Lanham Napier, who had led the company for 14 years.  Mr Napier noted that:

T'he transition has been challenging and has taken longer than we anticipated, but our ambitions for this game-changing transition are massive. I wanted to stay at the company long enough to see the transition through, and I feel like we're finally over the hump. Most of the heavy-lifting has been accomplished. So the company is positioned to continue forward'.
But social media wags noted that if prospects were so excellent...then surely he would stick around?  In my view is hard to comment on any specific situation.  Certainly though it contributed to pushing the stock down 10%+ in after hours trading yesterday. 
What I found more interesting though was the comment by the new (acting CEO - who was previously the Chairman and the CEO before the retiring CEO!) about how the company is going to compete against some of the well-known names noted above (with my emphasis added):
In 2014, we will continue to invest in our strategy of differentiating based on three core pillars. First, fanatical support, which positions us as the trusted choice for large and lucrative market segment that want exceptional service and values performance in contrast to the DIY, do-it-yourself, approach...Secondly, hybrid cloud. Hybrid cloud leverages our leadership position in the OpenStack and our heritage as the inventor of the managed hosting industry to offer each customer the right combination of the public cloud, private cloud and dedicated hardware...And finally, our position as the leading specialist in running open and standard technologies that our customers want to achieve their performance requirements'
You can sense from the above that the company is focusing very much on service, experience and history: the classic orientation for an incumbent. 
It remains hard-to-call whether this will work or not and given the numbers have not progressed, the valuation remains very punchy (x62 P/E FY14e). 
Whilst the market will push the shares down on the above, I go back to my late November/early December observation that the double bottom of US$35 shown below over the last year is still an interesting place to augment my (current) small position. 
I like the theme and note the competition...but also reiterate what I mentioned in November:
'With the market cap of the company now down below US$5bn, even with competition, what's the value of Rackspace's client base, related servicing and technological IP to a big name who wants to make a bigger splash in the cloud theme?'
High risk but potentially attractive bounce back review. 

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