We're suffering mixed feelings at Motley Fool Rule Breakers today. On one hand, Zipcar is off more than 10% on a weaker-than-expected outlook. But on the other, Rackspace Hosting
My Foolish colleague and Rule Breakers teammate Rick Munarriz has the details on Zipcar's fourth quarter, which allows us to dig into all the juicy goodness found in Rackspace's delicious report.
Let's start with the basics. Revenue zoomed 32% year over year and 7.1% sequentially in Q4. Net income improved 85% over last year's fourth quarter and 25.3% over Q3. Adjusted earnings per share came in at $0.18, two pennies ahead of estimates, according to S&P Capital IQ.
Still cloudy, with a chance of billions
Great as those numbers are, they don't fully express the leverage built into Rackspace's business model. For that you need to look deeper:
|
Metric |
Q4 2011 |
Q3 2011 |
Q2 2011 |
Q1 2011 |
|---|---|---|---|---|
| New revenue* | $18,689.0 | $17,343.0 | $17,227.0 | $15,276.0 |
| Additional servers | 1,088 | 4,689 | 3,555 | 4,458 |
| New revenue per server | $17,177.4 | $3,698.7 | $4,845.9 | $3,426.6 |
| Cloud computing as a % of revenue | 20.6% | 19.2% | 17.4% | 16.1% |
Sources: press releases, TMF estimates.
*Numbers in millions.
Notice how sequential revenue gains aren't necessarily bound to increases in server count? That's leverage at work. Nor is it an accident that the gains coincide with cloud computing sales that comprise an ever-larger slice of the revenue pie.
"Cloud" sales refer to general agreements in which Rackspace supplies certain levels of hosting service while determining which servers and what software to use in order to make good. Customers have zero control over how infrastructure gets deployed. These engagements produce lower revenue but higher margins, CEO Lanham Napier said in an interview.
By contrast, "managed" hosting agreements specify both the types of services Rackspace will provide and guarantees at least some measure of customer control over the equipment and software used. Think of it as renting a snowblower, whereas cloud hosting is more like paying someone to shovel your driveway after a storm.
Both models work for boosting revenue, but when you compare the numbers year over year, you can see that cloud hosting is much more efficient:
|
Metric |
Q4 2010 |
Q3 2010 |
Q2 2010 |
Q1 2010 |
|---|---|---|---|---|
| New revenue* | $15,016.0 | $12,396.0 | $8,509.0 | $9,289.0 |
| Additional servers | 2,019 | 2,122 | 1,998 | 3,205 |
| New revenue per server | $7,437.3 | $5,841.7 | $4,258.8 | $2,898.3 |
| Cloud computing as a % of revenue | 14.6% | 13.4% | 12.4% | 10.8% |
Sources: press releases, TMF estimates.
*Numbers in millions.
Cloud engagements are also easier to sell, judging by the numbers. Rackspace has added at least 9,000 new customers in each of the past four quarters. More than 172,000 were using its hosted platform as of Dec. 31, up from 130,000 the year prior. Gross margins are up 180 basis points over that period.
Moving up the value chain
What's interesting is how customers are viewing the cloud today versus how they did a few years ago. Today, they're more inclined to believe that a Web-based infrastructure can deliver as reliably as one built and hosted in-house. Rackspace is selling into this belief with what it calls a "Managed Cloud" offering that guarantees certain levels of service that, not long ago, would have required customers to create their own data center.
In our interview, Napier admitted there's a challenge to scale up Rackspace's own infrastructure to deliver at such a high level. But he also believes it's the best way to differentiate against Amazon.com's
So far, the strategy is paying off. Rackspace is doing more to squeeze revenue and profit from its deployed assets. Gains in Q4 were overstated some because of excess server capacity built up in the second and third quarters, but normalizing for the full year shows monthly revenue per server improved 9.8% over 2010's average. Returns on capital improved 301 basis points over the same period.
Making the call: buy
As a member of my Big Idea Portfolio, Rackspace is a stock worth buying. I still believe that. Not only is the company making strides in every metric that matters, but there's also the fact that only a small portion -- perhaps less than 20% -- of customers that have scaled up their commitment to the Rackspace Cloud. As that ratio increases, so will profits, returns on capital, and, ultimately, shareholder returns.
Do you agree? Disagree? Either way, it makes sense to study how the Internet has changed computing. The Motley Fool recently dug into this trend in a video research brief titled "The Two Words Bill Gates Doesn't Want You to Hear." The report is free, but only for a limited time, so watch it now!
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