RackableSystems (Nasdaq: RACK ) provides data-center server solutions tailored specifically to its customers' needs. Its servers lower the total cost of ownership with better density, improved power management, and an open architecture that minimizes compatibility issues. With an $870 million market cap, this recent IPO is a player in the "scale out" niche, where companies deploy hundreds or even thousands of inexpensive servers to address applications that once required supercomputers. Given its compelling business, it's no surprise that Rackable stacked up impressive growth numbers in its recent third quarter.
Revenues were up 40% year over year to $80.5 million, with higher-margin storage revenues comprising 16% of revenues, up from 8% last year. With gross margins of 21.4% for the quarter, and a net loss of nearly $400,000, it's clear that volume will continue to drive the company's top line. Strong margins and profits will have to come from the storage business.
I think Rackable currently maintains a slight competitive edge over competitors like Sun Microsystems (Nasdaq: SUNW ) in the "scale out" market. Its products are designed specially for data centers, whereas competing products tend to be more generic. For example, Rackable has neatly addressed the heat dissipation problem that typical servers run into when placed by the hundreds in a standard rack in a data center; its systems offer the option of using DC power rather than AC, with external rectifiers that can be placed far away from the servers. Without internal power supplies, the servers generate less heat than conventional servers, and require less effort to keep their surroundings cool.
In addition, the company has designed its servers to be as compact as possible. With companies like Google (Nasdaq: GOOG ) and Microsoft (Nasdaq: MSFT ) spending millions of dollars on data centers, every inch of space is important. Rackable's servers are half as deep as traditional rack-mounted systems. Combined with the ability to connect the servers not only side to side but back to back, it's able to squeeze twice as many systems into the same space as its competitors.
While I have a soft spot for bleeding-edge technology, I've also learned that red-hot technology doesn't always make a smart investment. Rackable's anything but cheap, trading at roughly 50 times management's 2007 earnings estimate. With margins as low as they are, I need to see this story develop further before I consider risking my hard-earned capital.
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