Is Rackspace's Cloud Business in Big Trouble?

Unlike its peers, Rackspace will not be making price cuts to its cloud business. Will this ultimately mean stock losses?

Apr 11, 2014 at 2:00PM

Apparently, Rackspace (NYSE:RAX) is a premium service provider that doesn't feel it necessary to lower the prices of its cloud infrastructure, or laaS, products to match competitors. These competitors include juggernauts Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG), and Microsoft (NASDAQ:MSFT), just to name a few. Is Rackspace making a mistake, and if so, how will this decision impact its stock?

Rackspace: Cloud products are important
If you're an investor in Rackspace, much of the reason has to do with its cloud infrastructure business, also called its public cloud revenue. In the company's last quarter, it reported revenue of $408 million, which was good for growth of 15.6% year-over-year. However, nearly one-third of that revenue came from its public cloud business, a unit that grew 34%, which includes its cloud infrastructure business.

Albeit, Rackspace's cloud infrastructure business is growing at twice the rate of its total revenue. Still, Rackspace has consistently seen its market share decline, as was the case last quarter. Revenue from cloud is growing slower than the overall industry. Particularly, laaS, combined with cloud app platform, or PaaS, grew 52% in the fourth quarter. However, investors have been satisfied with Rackspace's growth, although it has been noticeably slower than the overall market.

An industrywide trend
Rackspace's cloud business is important to its overall valuation, and the company faces the toughest of competition possible. Google, Amazon, and Microsoft all have a sizable presence in this fast-growing arena, and each have made moves to strengthen their position in the space.

Google's market share of the laaS/PaaS market stood at roughly 5% in the fourth quarter of last year, or $150 million. While this looks fairly insignificant relative to its overall business, this market reached nearly $10 billion last year, with over $3 billion in the fourth quarter alone. Hence, it's a market that Google wants to control, and therefore has cut laaS and PaaS prices by 32% and 30%, respectively, to gain market share.

Microsoft saw its cloud business more than double in the fourth quarter of last year to exceed $200 million, giving it a total market share or more than 7%. In response to Google's price cuts, Microsoft cut prices from 27%-35% across all cloud product offerings, showing its desire to own this space.

However, Amazon is the current kingpin; Amazon Web Services, or AWS, has a market share over 30% and grew a whopping 65% in the fourth quarter. Yet, despite this dominance, Amazon slashed prices following Google's cloud cuts. The majority of its top cloud services saw price cuts of 30% of more, making it the 42nd cut in AWS's history. Clearly, Amazon wants to protect its position, as the business generated $3.7 billion last year and is now worth $50 billion, according to Evercore.

What is Rackspace doing about it?
Rackspace is facing some tough competition, and investors must wonder how the company plans to compete against this arsenal of tech juggernauts. According to chief technology officer John Engates, Rackspace provides premium services and does not base pricing on the actions of competitors. In other words, Rackspace is not going to match its price-cutting peers.

The problem is that Rackspace does not have an edge, nor a premium product. According to The Channel, Rackspace charges $0.68 per hour for a 15GB cloud server with SSD storage. Yet, for an equivalent product, Amazon now charges $0.28, as does Google minus the SSD storage.

Final thoughts
Essentially, Rackspace charges a premium of more than 140% for nearly identical technology offered by peers Google and Amazon. To conclude that price cuts are not necessary is absurd.

With that said, these price cuts are sure to affect Rackspace, and without as much leverage, it appears that Rackspace is willing to try its luck in an attempt to maintain growth and protect margins. However, this ideology will likely falter, and the only logic needed is common sense: A discount of 50% or more for an equal product equals bad news for both Rackspace and investors.

3 stocks poised to be multi-baggers
The one sure way to get wealthy is to invest in a groundbreaking company that goes on to dominate a multibillion-dollar industry. Our analysts have found multi-bagger stocks time and again. And now they think they've done it again with three stock picks that they believe could generate the same type of phenomenal returns. They've revealed these picks in a new free report that you can download instantly by clicking here now.

Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends, Google (C shares), and Rackspace Hosting. The Motley Fool owns shares of, Google (C shares), and Microsoft. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information