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Why Rackspace Hosting, Inc. Shares Plummeted

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Rackspace Hosting, Inc. (NYSE: RAX  ) plunged more than 14% during intraday trading Tuesday after the company reported mixed third-quarter results.

So what: Quarterly net revenue rose 16% year over year to $388.6 million, which translated to a 40% drop in net income over the same period to $16.3 million, or $0.11 per diluted share. By contrast, analysts were looking for higher earnings of $0.16 per share on lower sales of $387.47 million.

Now what: If you're searching for the culprit for Rackspace's lower profitability, look no further than the company's increased capital expenditures. In all, Rackspace management suggested it will "probably spend around $460 million to $510 million on total CapEx for the year," compared to previous estimates for capital expenditures in the range of $375 million to $445 million.

To explain much of the increase, CFO Karl Pichler said Rackspace made investments in equipment to focus on "accelerating and globalizing the launch of [its] performance cloud."

That's fair enough, especially considering Rackspace's earnings weakness can't be attributed to flaws in its overall business model. Besides, the cloud segment is an increasingly important growth driver for Rackspace as growth from its traditional web hosting segment slows, so it makes sense to push forward its implementation as competition in the space intensifies.

As a result, even though shares of Rackspace look expensive trading north of 50 times next year's estimated earnings, I think today's pullback could be a great opportunity for long-term investors who don't mind waiting for the fruits of its current spending spree to materialize.

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9/30/2016 4:02 PM
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