What is it doing right?
Despite the lower than expected revenues, the company’s operating profit grew by 19%, matching analyst expectations. Further, the company has been able to maintain its operating profit margin, which increased 120bps to 13% in 2012. This is an indication that the company is able to manage its variable costs. Going forward, this will be an important metric to watch out for, as it will reflect the customer reaction to the reduction in prices.
Further, the CEO Lanham Naiper mentioned strong growth prospects for the company. It expects to deliver growth as companies migrate to cloud data centers from their internally managed, slower and expensive servers. This is further corroborated by the strong 49% growth in its cloud computing service segment, which now accounts for 25% of its total sales (up from 21% last year).
It is also committed to innovation, constantly developing different ways of interaction with the cloud network. Its OpenStack public cloud is one such product that distinguishes it from its competitors. Until now, cloud computing had limited inter-operability, while on the other hand the OpenStack public cloud will allow interaction between many different cloud networks. This means it will function just like the Internet where many service providers can operate in conjunction with one another rather than having to rely on it internal processes which generally have lower compatibility.
Further, the company is also focused on tapping the increasing demand in mobile technologies, which is expected to account for approximately 57% of total IT industry growth in 2013 (according to IDC). Rackspace Hosting, Inc. (NYSE:RAX) recently launched a pre-configured mobile stack specifically for mobile applications, which will help to reduce complexity for mobile developers and will enable them to innovate faster.
Competition
As mentioned earlier, there are a number of companies in the cloud computing space. Two key competitors include Citrix Systems, Inc. (NASDAQ:CTXS) and Red Hat, Inc. (NYSE:RHT).
Citrix Systems, Inc. (NASDAQ:CTXS) is much larger in size versus Rackspace Hosting with $13 billion market capitalization and $2.5 billion revenue. Its operating margin is higher at 15%, which means that it is able to manage its expense well. However, its quarterly revenue growth of 19% is not as impressive as Rackspace Hosting’s 25%. But it is has a good PEG ratio of 1.26 meaning that the company is relatively undervalued versus its peers.
Next is Red Hat, Inc. (NYSE:RHT), which is more comparable to Rackspace Hosting with $9.7 billion market capitalization and $1.3 billion revenue. Again, in comparison with Rackspace Hosting, this company has much better margins of 18%. Red Hat recently reported its 4Q12 numbers with revenues increasing 17% but missing analyst expectations by a modest $1.6 million. CFO Charlie Peters hinted that revenues were hindered by its aggressive investments in new categories like storage, cloud computing, management and big data, but at the same time also mentioned that they come with positive signs of long-term goals. But looking at its PEG ratio of 2.33, it seems the stock is overvalued.
On the balance sheet front, Citrix and Red Hat both have managed to maintain a debt free balance sheet, while Rackspace Hosting has a debt/equity ratio of 15%. Further, Rackspace Hosting has a lower cash balance of $292 million versus Citrix and Red Hat’s strong balances of $928 million and $879 million, respectively.
Conclusion
Out of the three, Rackspace Hosting has a strong historical return of equity of 15% and also a modest PEG ratio of 1.76. But the real test will be if the company can demonstrate that it has the requisite scalability to support this movement as well as be able to wade through the rising price competition. With the current pullback in share price it is a good time to invest but keep an eye on the revenue growth and its competition.
The article The Cloud War originally appeared on Fool.com and is written by Sujata Dutta.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
