Rackspace Hosting, Inc. Earnings: Will Price Wars Kill the Cloud Provider?

Rackspace has been in a downward spiral lately, but can it bounce back?

May 10, 2014 at 4:33PM

On Monday, Rackspace Hosting (NYSE:RAX) will release its quarterly report, and shareholders have seen the stock plunge in response to new competitive pressures. With Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Amazon.com (NASDAQ:AMZN) among many companies vying for dominance in the cloud-computing arena, Rackspace will have to work harder to cement its place in the industry and keep from getting squeezed out by its rivals.

Rackspace's business strategy has been to provide premium services for customers looking to take advantage of the power of cloud computing. Yet cost-conscious enterprise customers can be notoriously disloyal when bargains come around, and as Amazon, Google, and other players have recently started a race to the bottom in terms of pricing, Rackspace's shareholders have started to lose confidence in the company's ability to compete. Let's take an early look at what's been happening with Rackspace Hosting over the past quarter and what we're likely to see in its report.

Rax
Source: Rackspace Hosting.

Stats on Rackspace Hosting

Analyst EPS Estimate

$0.12

Change From Year-Ago EPS

(37%)

Revenue Estimate

$419.53 million

Change From Year-Ago Revenue

15.8%

Earnings Beats in Past 4 Quarters

1

Source: Yahoo! Finance.

Will Rackspace Hosting earnings start rising again?
In recent months, investors have gotten less optimistic about Rackspace earnings, cutting 20% from their first-quarter estimates and 10% to 15% from their full-year 2014 and 2015 projections. The stock has plunged, falling 29% since early February.

Rackspace Hosting's fourth-quarter results revealed the challenges that the company has gone through lately. Revenue jumped 16% from the year-ago quarter, but that only heightened concerns about a growth rate that has gotten chopped in half in just the past two years. Moreover, profits fell by a third, and even somewhat favorable guidance for the coming year wasn't enough to prevent a double-digit sell-off in Rackspace stock.

Rax

Source; Rackspace Hosting.

The biggest problem that Rackspace faces right now is a competitive tug-of-war between Amazon and Google. Amazon was first into the commoditized cloud-services realm, and its Amazon Web Services has leading market share across the industry. But Google has tried to capture some of that share by cutting prices, and Amazon, not to be outdone, hasn't hesitated to follow suit. As Google and Amazon have both attracted more customers to its service, Rackspace risks getting left out of the shuffle, especially since it has to rely on its clients being willing to pay premium prices for more individualized service and support.

In particular, Rackspace risks losing the lucrative large-enterprise business to Google and Amazon. Rackspace has a much stronger reputation among smaller businesses, where its public cloud service has No. 2 market share. But large-enterprise customers produce much greater revenue than smaller users, and that makes it important for Rackspace not to content itself as a small- and mid-sized business specialist.

Still, Rackspace has to come up with a viable strategy to compete. It's likely that Rackspace will need to cut its prices at least to some extent, threatening its already slowing revenue growth and profitability. Alternatively, Rackspace needs to develop even more premium service offerings that enterprise customers will be willing to pay up for, and that poses a huge challenge given the much greater resources that Amazon, Google, and other big-tech peers have in meeting customer needs.

In the Rackspace earnings report, watch to see how well the company's sales and net income hold up in the Amazon-Google price war. Without more to distinguish its service from its rivals', Rackspace could have trouble boosting its stock price back from its current lows.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Google (A and C shares), and Rackspace Hosting and owns shares of Amazon.com and Google (A and C shares). Try any of our Foolish newsletter services free for 30 days. 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.

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