Rackspace Hosting Dives on Unclear Buyout Progress

Shares of Rackspace Hosting took another large dive this week, as solid second-quarter results were outweighed by a lack of clarity on buyout talks.

Aug 14, 2014 at 11:00AM

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Source: Rackspace.

Shares of Rackspace Hosting (NYSE:RAX) took a tumble on Tuesday, following the release of second-quarter results. The stock fell as much as 7.4% in spite of in-line results and reasonable guidance, as investors were left without an update on Rackspace's strategic review process.

In prepared remarks, CEO Graham Weston relished a number of all-time record metrics. Revenue rose 17% year over year to stop at $441 million. Average monthly revenue per server was $1,375, a 5.9% increase from the year-ago period, which shows pricing power and underscores Rackspace's highly efficient operations. On the bottom line, GAAP earnings held steady at $0.16 per diluted share.

Earnings were in line with analyst estimates, and sales came in slightly stronger than expected. Looking ahead, management's revenue guidance for the third quarter was slightly ahead of the current Street view.

The company added thousands of new clients while expanding orders from existing customers. Earnings and cash flows didn't break any all-time records, but were solidly in positive territory, as usual.

RAX Revenue (Quarterly) Chart

RAX data by YCharts.

In the second quarter, Rackspace responded to a price war across the virtual server hosting space. Google (NASDAQ:GOOG) (NASDAQ:GOOGL) reduced its Compute Engine prices by 4% at the very start of the April-to-June quarter. Twelve hours later, Amazon.com (NASDAQ:AMZN) hacked 26% off the hourly charges for some of its Elastic Compute Cloud services. Two weeks later, Microsoft (NASDAQ:MSFT) committed to matching Amazon's pricing in the Windows Azure cloud hosting service.

Rackspace didn't exactly join this percolating price war by lowering prices. Instead, the company phased out its existing lineup of cloud server options and introduced a new series of so-called performance servers. These cloud servers all come with formerly high-end hardware such as high-speed solid state drives, error-correcting memory modules, and speedy network links. But above all else, they can be ordered alongside support levels that Microsoft, Amazon, and Google simply don't offer.

In short, Rackspace is betting the farm on its "fanatical support" calling card. CEO Graham Weston said as much in the announcement: "The cloud market is evolving. More customers are looking for a trusted partner with specialized expertise to help manage their cloud," he stated. "Our new service levels will help businesses tap the power of the cloud without the pain of recruiting experts in dozens of complex technologies. We are the partner that will be with them every step of the way to help make their cloud strategy successful."

In this week's earnings call, Rackspace president Taylor Rhodes explained this attitude further:

No one in the industry can touch Rackspace when it comes to Fanatical Support. [...] As the cloud market moves from the early adopter to the mainstream phase, more and more companies of every size and technical sophistication level are realizing that there is a lot more to making the cloud produce value than getting seemingly low price per unit hour of compute.

So Rackspace is committed to this strategy. That being said, some of these "performance" servers do compete with Windows Azure, Amazon ECC, and Google Compute Engine on a pricing level.

The Foolish takeaway
All of this sounds reasonably optimistic, yet shares plunged on the news. Again, investors were hoping for some meat on the bare bones of Rackspace's strategic review, such as incoming buyout offers or game-changing investments.

Graham acknowledged the review process but failed to set a timetable or any other parameters for its progress. "At this point in time, evaluation is ongoing," he said. "We do not intend to comment further on this issue at this time." Later, Rhodes declined to provide long-term guidance "in the midst of speculation about our strategic options."

The cloud computing market, where Rackspace makes its hay, can seem baffling at first. To learn more, check out fellow Fool Evan Niu's explanation of the SaaS, PaaS, IaaS alphabet soup

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Anders Bylund owns shares of Google (A and C shares) and Rackspace Hosting, as well as a synthetic long position on Amazon.com. The Motley Fool recommends Amazon.com, Apple, Google (A and C shares), and Rackspace Hosting. The Motley Fool also owns shares of Amazon.com, Apple, Google (A and 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.

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