Wednesday, 13 May 2015

Rackspace - never a dull moment...

I last wrote about the cloud based hosting and web traffic management company Rackspace here back in February when I observed that having made a good turn in the share earlier in the year I had sold out in favour of an investment in Amazon.  Well that worked out well in the last few months:

Rackspace is a funny old share.  Having plunged a number of times to the US$30-35 range, it has pushed up strongly for much of the last six months before having another sharp plunge after the publication of quarterly results on Monday.  

So what was said a couple of days ago?  Well the headlines seemed reasonable enough:

Revenue Grew 14 Percent Compared to the First Quarter of 2014
Adjusted EBITDA Grew 15.5 Percent Compared to the First Quarter of 2014
Net Income Grew 12 Percent Compared to the First Quarter of 2014

However the issue was with the guidance as Seeking Alpha noted:

'Rackspace's (NYSE:RAX) guidance for Q2 revenue to be up 1.5%-2.5% Q/Q in constant currency implies Q2 sales will fall short of a consensus of $502.1M (+4.6% Q/Q in actual dollars)'.

Additionally some of the operational and financial metrics were starting to lag:

'Average revenue/server was $1,412, flat Q/Q and up $76 Y/Y; it had been rising Q/Q in prior quarters...No buybacks took place; $200M was spent on them in Q4'

Additionally other, bigger, competitors continue to grow much faster: 

'Amazon's AWS revenue rose 49% Y/Y in Q1 to $1.57B, and Synergy Research thinks Microsoft, IBM, and Google saw even faster IaaS/PaaS cloud service growth (albeit off much smaller bases)'

This point is excellently summarised by this graphic (sourced from here):

Playing with the big boys indeed.  Well the switch to cloud is a really huge theme...

Looking through the conference call transcript the inevitable mention of 'lumpy' sales cycles was prominent as was the sprinkling of new business wins (including Tinder!).  The essential message was that sales were coming through and that the real edge over time to compete with larger entities comes from the open architecture orientation of Rackspace's key Openstack product: 

All reasonable - and predictable.  But what price to pay for all of this especially given the deterioration in some of the business metrics as noted above?

Looking at the recent numbers it is easy to see the challenge.  I noted before the c. x40 P/E rating and inferior cashflow to Amazon (see here for my take on their continuing efforts on this front)...

...which maybe just leaves you with the technicals (certainly sub US$40, quite possibly sub US$35) to work with unless you want to attribute possibilities to the 'strategic value/positioning'.  That's always a tough call even if cloud-based expansion in this space is a given.  Stronger growth levels would help that view.  My view after the latest quarterly is to trust the technicals.  Therefore at prevailing I am on the sidelines.  

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