Rackspace's 1,000 Cuts Spell More Pain but Not Death

Rackspace is feeling more pressure this week but there is great value in the company.

Apr 1, 2014 at 2:00PM

Shares of Rackspace Hosting, (NYSE:RAX) had another difficult week as both Amazon and Google cut pricing of cloud services. Shares ended down 5.3% for the week and 20% for the year as investors sold ahead of the first quarter closing on Monday. Looking ahead, it is difficult to see how Rackspace will not be affected by this new round of cuts.

Cost cutting is accelerating, not slowing
Google, (NASDAQ:GOOGL) fired its most recent shot at Amazon on March 25, when it cut prices massively in an attempt to bring cloud computing pricing in parity with Moore's Law. The price cuts amounted to a drop in on-demand, pay-as-you-go services by 30%-85%. 

Amazon.com, (NASDAQ:AMZN) fired back a day later in a blog posting that begins with the sentence: "It is always fun to write about price reductions." Amazon and Google are competing for the reputation of being the low-cost services player and the award that goes to the winner is the hearts and minds of developers. This price cut by Amazon is the 42nd since 2008, and there is no sign of it stopping anytime soon.

Amazon's blog post, goes on to tell customers that these reductions will be applied to their bills without any action on their behalf. You have to love this. When was the last time that your cable bill dropped because Comcast's equipment prices fell?

Amazon and Google are giving their profits back to the customers and they can afford to do this because the businesses are being funded by other operations. That isn't the case for Rackspace and it's now hitting the financials. In 2013, many of the traditional metrics used to gauge successful growth improved. Revenue of $1.1 billion, grew 11%, the number of employees grew 16.5% to 5,651, and the number of servers deployed grew 14.8% to 103,886. Unfortunately, profits reversed direction as income from operations declined to $133 million, down 22.9% from 2012.

Financial impact will be greater in 2014 than 2013
Looking ahead, it is difficult to know how much of an impact pricing can have on the financials, which is the most direct correlation to share price. However, the company has value to competitors in a host of different ways. Rackspace has consistently been at the cutting edge of cloud infrastructure development -- e.g., its joint project with NASA, Openstack. It is ranked as the 29th best company to work for by Fortune. By being at the cutting edge with a good corporate culture, the company has amassed a team of highly sought-after engineers, making it an interesting acquisition candidate for the likes of IBM, Amazon or Google.

What's a fair price for a great culture and intellectual property?
This leaves the question of price. What price would a competitor be willing to pay for the company? Looking at the issue using traditional metrics is difficult. The shares are trading at a trailing price-to-earnings ratio of 51, but the real forward P/E could be much greater. It's likely that a new CEO will fill the open slot left by its now-retired chief executive and slash costs, but it better happen quickly before the talent goes elsewhere.

Boost your 2014 returns with The Motley Fool's top stock
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

David Eller has no position in any stocks mentioned. The Motley Fool recommends Rackspace Hosting. It recommends and owns shares of Amazon.com and Google. Try any of our Foolish newsletter services free for 30 days. 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 has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers