San Antonio Spurs Assistant Coach Becky Hammon speaking at a recent Rackspace event. Credit: Rackspace Hosting.
Shares of Rackspace Hosting (RAX) jumped nearly 5% in late trading as investors ignored mediocre Q2 results and instead cheered plans for a $1 billion stock buyback. Here's a closer look at the Q2 totals versus Wall Street's projections:
| RAX | Revenue | YOY Growth | EPS | YOY Growth |
|---|---|---|---|---|
| Consensus estimate | $490.53 million | 11.2% | $0.20 | 25% |
| Q2 actual | $489.4 million | 10.9% | $0.20 | 25% |
| DIFFERENCE | ($1.13 million) | (0.3%) | $0.00 | 0% |
Sources: S&P Capital IQ and Rackspace Hosting press release.
Commenting on the results, CEO Taylor Rhodes said in a press release:
During the second quarter, we made progress on several key fronts, including with our 50 largest enterprise customers, whose spending with us is growing at more than twice the rate of our overall business. We expanded our managed cloud strategy by providing our expertise and Fanatical Support on Microsoft (MSFT -2.45%) Azure. We've launched a major partnership with Intel to make OpenStack public, private, and hybrid clouds easier to deploy, more scalable and more secure. And we continue to make progress toward building the market-leading managed services offer for customers on the AWS cloud.
What went right: Rackspace did a nice job controlling expenses and managed to boost its operating margin from 7.7% in last year's Q2 to 8.9% over the past three months. Annualized returns on capital rose to 12.1% from 10.1% for the 12 months ended on June 30. Careful management is as much a contributor to profit as strong sales. To cash in on that advantage, the board has authorized an additional $1 billion in share repurchases to go along with the $200 million authorization already in place. Rackspace plans to "complete at least $500 million" worth of buybacks in the next six to nine months, the press release says.
What went wrong: Revenue came short of estimates, and gross margin fell 60 basis points to 66.5% from 67.1% in last year's Q2. Cash from operations also dipped slightly despite higher overall net income in the second quarter, while monthly revenue per server has hardly moved since last year's Q3 -- climbing from $1,405 from the end of Q3 2014 to $1,412 for the next two quarters and then $1,416 in Q3. Finding ways to generate more value from existing infrastructure has to be a priority from here on.
What's next: Rackspace didn't include third-quarter guidance in its press release. Nevertheless, analysts tracked by S&P Capital IQ have the company generating $511.02 million in revenue and $0.22 a share in profit after accounting for stock-based compensation and other noncash items. That compares with $459.78 million and $0.18 a share, respectively, in last year's Q3.
Longer term, analysts have Rackspace growing earnings by an average of 21.81% annually over the next three to five years.
In the meantime, investors should pay close attention to revenue per server and gross margin. Accelerating gains in both areas would speak well for customer demand for the sorts of higher-priced managed services that are central to the thesis for investing in Rackspace.
