A Closer Look at Rackspace's Competitive Advantage

More than anything else, managers determine returns. They set strategy, hire key team members, oversee operations, and cash paychecks. Every move they make either enhances or destroys shareholder capital.

It pays to know who these men and women are, how they're paid, whether they, too, are owners, and how they perform versus competitors in certain key metrics. In this regular column, I'll examine all that and more with the goal of enhancing our understanding of some of the top stocks in Fooldom.

Next up: Rackspace Hosting (NYSE: RAX  ) . Is the executive team of this cloud computing superstar doing all it can to earn you outsized returns?

Foolish facts

Metric

Rackspace Hosting

CAPS stars (out of 5) ***
Total ratings 600
Percent bulls 93%
Percent bears 7%
Bullish pitches 54 out of 58
Highest rated peers Spark Networks, PHOTOCHANNEL NETWORKS, Internet Initiative Japan

Data current as of February 16.

For the most part, Fools love Rackspace's commitment to quality but remain skeptical of the stock's valuation. Shares of this web infrastructure supplier trade for nearly three times analysts' long-term earnings estimates, resulting in a 2.99 PEG ratio as of this writing.

"Though I typically try to find out of favor picks, I'll jump on this despite its lofty P/E. Either I'll get burned following the herd, or enjoy the ride into the clouds," wrote All-Star Fool miclane05 in December. The stock is up more than 24% since, and for good reason.

Rackspace blew away Street estimates for fourth-quarter revenue while profit soared more than 50%. Net margins improved by 100 basis points last year and cash from operations rose 24% to $244 million.

And yet this a growth story with legs. CEO Lanham Napier said in an interview following the report that the company is in the "nascent" stages of a cloud computing opportunity that could unlock billions in revenue. As the guy who's twice recommended Rackspace to our Motley Fool Rule Breakers members, I think he's right.

Management overview

Executive

Years

Cash Compensation

Shares Owned

Lanham Napier, Chief Executive Officer 11 $576,172 399,795
Bruce Knooihuizen, Chief Financial Officer 3 $525,840 67,047
Lew Moorman, Chief Strategy Officer 11 $333,352 723,494
Mark Roenigk, Chief Operating Officer 1 $82,604 41,690

Source: Capital IQ, a division of Standard & Poor's. Data current as of Feb. 16.

Management inspires my confidence. Napier has 11 years in various roles with the company, beginning with Chief Financial Officer in 2000. Chief Strategy Officer Lew Moorman has been around just as long and leads the cloud computing business that today is driving efficient growth at Rackspace.

Rackers also tend to take a large share of their compensation via restricted stock awards. Napier and Moorman, in particular, have awards that vest based on the total long-term return of Rackspace's stock versus the top performing constituents of the Russell 2000 index. It's the sort of win-win plan that suggests the company loves investors almost as much as customers.

Management analysis versus competitors

Company

Insider Ownership

Gross Margin

ROC*

ROE**

Amazon.com (Nasdaq: AMZN  ) 20.31% 22.3% 13.5% 19%
Rackspace Hosting 22.25% 68% 9.2% 11.8%
SAVVIS (Nasdaq: SVVS  ) 6.02% 46.3% 1.7% (27.3%)
Terremark Worldwide (Nasdaq: TMRK  ) 8.94% 48% 3.4% (51.4%)

Source: Capital IQ, a division of Standard & Poor's. Data current as of Feb. 16.
* Return on capital. ** Return on equity. *** Not measurable.

Looking at this table, I think it's a close call between Rackspace and Amazon. But isn't that saying something? Amazon has proven to be a special business and the source of more than a few spiffy pops for our Motley Fool Stock Advisor scorecard.

More importantly, Rackspace has been improving in many of these metrics. Returns on capital are up 280 basis points since 2008. Normalized profit growth has accelerated in each of the past three years. So say what you will about hosting being a commodity business. Rackspace excels at it, and investors have enjoyed the fruits of its success.

Now it's your turn to weigh in. Let us know what you think about Rackspace's products, valuation, competitors, and long-term opportunity using the comments box below. You can also rate Rackspace Hosting in Motley Fool CAPS.

Interested in more info on the stocks mentioned in this story? Add Amazon.com, Rackspace Hosting, SAVVIS or Terremark Worldwide to your watchlist.

Rackspace Hosting is a Motley Fool Rule Breakers selection. Amazon.com is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Power-One and is also on Twitter as @TheMotleyFool and its disclosure policy is managing just fine, thanks.


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  • Report this Comment On February 18, 2011, at 1:14 PM, MITCHDOG1029 wrote:

    RACKSPACE IS ONE OF MY CORE STOCKS AND IVE HAD THE STOCK SENCE SEPT,2010.BUT I WANT TO THINK THE FOOL FOR ALL OF THEIR STOCK PICKS.SOME OF CORSE ARE NOT LIKE RACKSPACE,BUT ARE GOOD FOR MY IRA.

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