Rackspace Hosting, Inc. (RAX) was founded by San Antonio, Texas-native Graham Weston and a partner in 1998, when they supplied capital for a business idea provided by three local university students. To this day, the company remains headquartered in San Antonio, with Weston as its Chairman, after serving as CEO until 2006. Rackspace provides hosting for companies that wish to outsource such information technology work. Demand for this hosting has been strong, with the company adding thousands of customers each year. At the end of 2011, there were about 172,000 business customers, with no client making up more than 2% of net revenue. Consequently, Rackspace has delivered solid top- and bottom-line growth since it went public in 2008, powering its stock’s price rapid ascent in the meantime.
Rackspace is a service-oriented technology company. This is evident in its corporate culture. For one, employees (Rackspace has more than 4,500) are colloquially known as “Rackers”, and their number has been growing fast. Another example of the company’s culture is that it refers to the level of its customer service as “Fanatical Support.” The company even explains these terms in its SEC filings. With a strong service culture, Rackspace differentiates itself from other hosting providers. Its business model also benefits, as offerings can generally command higher margins when they are more service-oriented.
The company reports in two product categories, Dedicated Cloud and Public Cloud. Dedicated Cloud refers to computing services the company provides on hardware specifically dedicated to a given customer. Public Cloud is a service that can draw on varying resources at the company. This can be called infrastructure as a service (IaaS). Public Cloud has been recently outperforming, with third-quarter revenues more than 55%. This is the first reporting period to include contributions from the OpenStack software.
OpenStack is a project, founded by NASA and Rackspace, to create an open-source cloud computing software platform. Support for the project has expanded gradually to include 190 businesses (including heavyweights like HP (HPQ - Free Hewlet Packard Stock Report), IBM (IBM - Free IBM Stock Report) and Dell (DELL)) and 6,000 individuals. Rackspace has launched seven new products to support users of this software. Nevertheless, the company notes that clients can avoid being locked in to any one vendor by using OpenStack. This software competes directly with the larger Amazon (AMZN) Web Services, which offers a scalable cloud computing platform. Other competitors include VMware Inc.’s (VMW) cloud-related offerings and a software called CloudStack.
Rackspace’s success depends on adoption of OpenStack during this critical new year. In a positive sign, Rackspace issued a press release in December stating that thousands of customers are signing up each month for the company’s open cloud services. On the other hand, interest also seems to be building for competitor CloudStack, according to some metrics. Meanwhile, Dell has said that it may wait until the end of 2013 to launch its OpenStack public cloud solution, so that the open-source software has more time to mature.
One thing is for sure. OpenStack or not, Rackspace stock has been on a tear since its initial public offering. Indeed, from an IPO price was $12.50 a share, it has risen more than 600%, growing over 40% annually, on average, to about $80 now. And though momentum continues this year so far, the company has lofty expectations priced in; Rackspace stock’s price-to-earnings ratio has been well above the market average through the issue’s trading history. Any setback in earnings growth could hurt the richly capitalized stock price.
Note also that the company reports fourth-quarter earnings in mid-February. The results should shed more light on how OpenStack-related business will fare, and how it is affecting Rackspace’s bottom line. For more information on specific investment attributes of Rackspace stock, see our quarterly updates regarding the issue in the Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.