Rackspace Hosting, Inc. Gives Investors Reason to Hope Again

A better-than-expected earnings report pushes the stock higher. But it’s a pair of metrics that should matter most to investors.

May 12, 2014 at 11:53PM

After months of disappointment and a plummeting stock price, Rackspace Hosting, Inc. (NYSE:RAX) finally managed a quarterly performance worthy of an after-hours pop.

Shares of the cloud computing specialist moved as much as 12.5% in late trading on first-quarter results that beat expectations. Rackspace's second-quarter outlook also impressed. (My Foolish colleague Anders Bylund has all the details here.)

The better news, of course, is that Rackspace's strategy seems to be working. Big investments in Openstack infrastructure have paid off in higher revenues per server and improving returns on capital:

Metric
Q1 2013
Q4 2013
Q1 2014

Revenue growth rate (YoY)

20.2%

15.6%

16.2%

Gross margin

68.6%

67.2%

66.7%

Return on capital (annualized)

15.1%

9.6%

11.4%

Servers in operation

94,122

103,886

106,229

Monthly revenue per server

$1,308

$1,322

$1,336

Sources: S&P Capital IQ, Rackspace Hosting press releases.

Looking at this table, two things stand out:

  1. Rackspace is earning more despite pricing pressure. Notice the slight decline in gross margin? That's where pricing pressure appears to be taking a toll, and yet revenue -- and revenue per server -- is still on the rise.

  2. Rackspace hasn't stopped investing. Seeing more than 12,000 new servers pressed into operation over the past year lends credence to interim CEO Graham Weston's claim that Rackspace today is chasing a bigger opportunity today than it was 15 years ago.

Next step: Go on the road
In a brief interview, Rackspace director of finance Bryan McGrath said that Rackspace is winning the business it most wants: customers who have complex deployments that demand a higher level of service than what Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:GOOGL)(NASDAQ:GOOG) offer with their own cloud offerings.

Company president Taylor Rhodies echoed those same sentiments in my conversation with him last month for Motley Fool Rule Breakers.

"Ideally, we want to get the chance to engage in the conversation about [price and value] because when we do, we have a very high hit rate. The danger is if we don't get the chance to explain it, and that's where our mission in the market is -- to go out and really articulate our story," Rhodes said. (Full interview available with subscription.)

And how will Rackspace achieve that? By going on the road. McGrath said that Rackspace plans to host a series of events in in which current customers will explain to prospects why they bet on its open cloud approach. Investors might do well to track how well attended these events are.

Now it's your turn to weigh in. What do you think of Rackspace's strategy? Do you believe better marketing will restore the growth investors had become accustomed to? Leave your take below, including whether you would buy, sell, or short Rackspace Hosting stock at current prices.

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Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team and the Motley Fool Supernova Odyssey I mission. He owned shares of Google (A and C class) and Rackspace Hosting at the time of publication. Check out Tim's Web home and portfolio holdings, or connect with him on Google+Tumblr, or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool recommends Amazon.com, Google (A and C shares), and Rackspace Hosting and owns shares of Amazon.com, Google (A and C class). 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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