It might be pie-in-the-sky thinking that
Rackspace Hosting (NYSE:
could overtake Amazon Web Services as king of cloud hosting -- at
least not in the near future.
That's not necessarily a bad thing for investors. While
enormous profile has cast a shadow over Rackspace for some time
now, being No. 2 in this arena is nothing to sneeze at.
Back in March 2012, my StreetAuthority colleague David Sterman
named RAX one of the most overvalued stocks in the market -- but
these days, Rackspace is getting some rather special attention at
current prices. When Dave's article was published last year, RAX
sold for about $54. It subsequently grew even more expensive, to
nearly $78 a share this January, but it has since fallen nearly
50% from that high.
Last Monday, RAX's share price of $49.31prompted investors to
acquire 21,687 call options on the company, about 815% more than
usual. That same day, Rackspace reported third-quarter earnings,
showing higher than expected revenue ($389 million, up15.7% from
a year ago) but lower than expected earnings per share (
), which came in at $0.11 compared with the $0.16 expected.
So, you had some investors selling shares -- price fell by 12%
mid-day -- and others betting that the stock would go up. Here a
few possible reasons for the dichotomy.
Rackspace's earnings miss was due in part to the company's
bigger than expected investments on new Performance Cloud
Servers, a move being applauded by its critics and one that
differentiates itself from Amazon. Without getting too technical,
the servers use Intel's
Xeon E5 processors with 120 GB of RAM, meaning they're faster,
more reliable and less prone to failure.
According to IT research firm IDC, "Everyone is gunning for
(Amazon Web Services) right now, and performance is one area
where competing public clouds feel they can differentiate from
Another factor in Rackspace's miss on earnings might be the
nearly 4,800 physical servers it added in the second quarter,
which marked a significant increased from the previous two
quarters and brought its total number to just shy of 99,000.
After being criticized for the slow pace of growth in its
cloud computing business, this was welcome news for investors.
The reason for all the new servers: a deployment of new cloud
infrastructure in Virginia, Australia and Hong Kong that required
added capacity -- which, by the way, is all due to be upgraded
soon with Xeon E5 processors.
Unfortunately, Rackspace has been caught between a rock and a
hard place. On one hand, as new business churns out revenue, the
$5.9 billion company also requires more servers and additional
capital expenditures. As a result, second-quarter investments
totaled $119.8 million, compared with $188 million for the
previous two quarters combined.
"We've increased our investment levels to play for a bigger
long-term outcome," CEO Lanham Napier says. "This is how we see
things right now. We think now is the time to really go for it."
Some analysts and the financial media think so too.
• Fortune magazine, citing Warren Buffett's famed advice
"to be fearful when others are greedy, and be greedy when others
are fearful," reported that RAX is now considered oversold
according to its relative strength index reading.
• JMP Securities concluded Rackspace made a worthwhile
investment in the new servers and expects the company to grow 20%
in 2014 with a target price of $67.
• Oppenheimer reiterated a buy rating on RAX with a $62
On the other hand, analysts at Evercore Partners cut their
number from $56 to $52.50.
Risks to Consider:
With a 52-week low of $34, RAX may have more room to fall in
the short term, especially after an earnings miss. There's also
the obvious risk that Rackspace's capital investments might not
pan out as expected.
Actions to Take -->
Much like Amazon, Rackspace is a great long-term
investment. I wouldn't be actively trading RAX; I would use the
200-day moving average -- which currently stands at just under
$45 -- as a buy trigger.
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