Rackspace Hopes OpenStack Becomes Cloud Standard

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A global appetite for connectivity is raging.

The cloud-computing companyRackspace Hosting ( RAX ) stands ready to quell that hunger. "We live in a hyperconnected world," says CEO Lanham Napier. "All of us have more information and data demands than ever before."

This macro trend has played right into the company's strong suit. "It needs a brain at the center and the cloud is that brain," Napier says of the movement. "Rackspace is standing at the epicenter of the cloud."

Napier has been with the company since 2000 and is presently guiding it along a spectacular run. Revenue and profits are way up at Rackspace as is the company's stock price. Shares have climbed 37% this year and are up 70% from a year ago.

With cloud offerings from heavy hitters such asAmazon ( AMZN ),VMware ( VMW ) andHewlett-Packard ( HPQ ), there is certainly no shortage of competition in the industry. Rackspace has made its mark by using an open-source platform known as OpenStack to power its cloud portfolio.

The company partnered with NASA to launch the software in 2010 and has since built a burgeoning support business around OpenStack. The OpenStack project now has the backing of more than 180 companies. It also appeals to customers seeking to avoid vendor lock-in.

"We've discovered that the marketplace really wants an open set of technologies for cloud," Napier says. "Over time, open systems tend to innovate faster and reach a greater scale."

Dedicated Cloud

Rackspace derives the lion's share of its revenue from its dedicated cloud hosting business. These services are provided on servers reserved for specific corporate customers. In Q2, 77.2% of the company's $319 million in net revenue came from dedicated cloud.

Stifel Nicolaus analyst Todd Weller thinks this business segment still has room to run. "They're well-positioned to grow from their roots as a dedicated managed hosting company," he said.

The remainder of the company's revenue is generated from its public cloud business, which manages pooled IT resources for customers, including small businesses and individuals.

The complementary offerings are driving towering levels of growth. In Q2, Rackspace saw its top line spike 29% when compared to the year-ago quarter. The previous three quarters all witnessed revenue gains north of 30%.

These stellar sales figures have translated into a rich bottom line. In its most recent quarter, EPS for the company surged 38%. The prior three quarters experienced comparative improvements of 70%, 80% and 56%. "They've been a beneficiary of secular trends," Weller said. "We remain positive for the growth story for Rackspace."

Jim Breen, an analyst for William Blair, holds similar sentiments. "Our outlook is generally favorable for Rackspace," he said.

Breen points to a widespread shift that he sees benefiting the company. "Managed services and cloud computing will continue to experience growth as IT services currently handled within organizations move outside," he said. "There is a pretty steady tail wind pushing the company along over the course of the next five or six years."

A major driving force behind the growth story at Rackspace thus far has been its customer service. "We believe technology is delivered as a service," CEO Napier says. "When you buy the service, you want to know that you will have a world-class experience."

Rackspace has a motto of providing "fanatical" support to its client base. Customer growth trends indicate that the formula is working. At the end of Q2, the company had 25% more customers than it did at the end of its Q2 in 2011. Compared to two years ago, its client base is up 77%.

The competition may want to tear a page out of the fanatical support playbook. "Technology companies have historically been terrible at service," Napier says. "As a customer, you want to be working with people you can trust."

In addition to maintaining its existing customers, Rackspace has set its sights on building its reach with new offerings. "As OpenStack thrives and prospers, other opportunities will present themselves," Napier says. "Recently, we were able to launch Rackspace Private Cloud, powered by OpenStack."

Rackspace expects the launch to have a lasting presence. It is a component of Rackspace's hybrid model, which the company designed to give customers the capabilities of public cloud with the customization and control of a dedicated environment.

Global Footprint

In addition to beefing up service offerings, Rackspace has plans to expand its global footprint.

In 2008, it pushed into the Asia Pacific market with the opening of a data center in Hong Kong. Earlier this month, that focus intensified with another data center in Sydney joining the mix.

"We're seeing a growing demand in interest for our services in the region," Napier says. "We expect to continue to make incremental investments there."

Napier thinks emerging markets will be quick to adopt the cloud. "Developing nations skipped land lines and went straight to mobile," he said. "In some ways, I think Asia Pac will skip some of the legacy ways IT has been run and go straight to cloud."

In its most recent quarter, Rackspace pulled in 25% of its net revenue from overseas.

Regardless of whether Napier considers the company's growth prospects from a service offering standpoint or a geographic vantage point, he sees plenty of upside. "We have an incredible opportunity in front of us," he says. "Our No. 1 challenge will be to execute on that opportunity."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: AMZN , HPQ , RAX , VMW

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