Shares of cloud computing specialist Rackspace Hosting (NYSE: RAX) took a 48% dive in 2013. Given that the S&P 500 index surged 29% higher at the same time, we Rackspace investors are feeling a bit sore at this point.
What happened in 2013?
Well, when Rackspace reported fourth-quarter results for 2012 in February, the stock was looking back at a tremendous 55% gain over the previous 12 months. Rackspace largely met sky-high expectations that time but followed up with weak and muddy guidance for the new year.
This is where I saw a rare buy-in opportunity and opened my own position in the stock. My Rackspace investment is down 35% since, because the company has indeed not impressed investors in 2013.
The stock plunged twice more on soft results and timid guidance. Rackspace caught a break in August, when the stock bounced 12% higher on a solid second-quarter report, but that was just a temporary respite.
What's going on?
From a bird's-eye view, Rackspace is going through some changes right now. The OpenStack cloud management platform was introduced in 2012 and is replacing all of Rackspace's old infrastructure this year. Yep, the OpenStack inventor eats its own dog food. But that means a few quarters of tricky operations, as Rackspace pours more resources into internal changes than into chasing new accounts, while current customers go through the pain of jumping to a new platform.
Rackspace CEO Lanham Napier saw this coming in January. "2013 will be transformational for Rackspace," he said. "We will step up and lead the Open Cloud movement while laying the foundation for massive growth ahead."
When Linux vendor Red Hat (NYSE:RHT) looks at OpenStack, that company sees a rocket booster driving its business faster and Red Hat shares higher. Platform backer Rackspace, on the other hand, sees nothing but pain so far. It's obvious to investors how Red Hat and other software builders monetize the OpenStack platform, but not so obvious how Rackspace intends to make any money on it.
Rackspace thinks of OpenStack as the Android of the cloud-computing world. Just like Android grabbed a dominating global market share in smartphones and tablets thanks to its open and customizable nature, OpenStack should be able to muscle out proprietary cloud models from Amazon.com (NASDAQ:AMZN) and VMware (NYSE:VMW) over time. Anybody can grab the code for free and modify it to suit their needs.
So it's easy to see why investors might be skeptical of Rackspace's role in this ecosystem. Even if OpenStack eventually makes VMware and the Amazon AWS cloud obsolete, how is Rackspace making money on giving it away?
Here's the trick
Rackspace's chief technology officer, John Engates, recently explained his company's strategy this way: "So if you're a sophisticated Chinese company and you have the capabilities that an Amazon or Google has in-house, you probably don't need us. But, again, there's a lot of companies that are reaching out to Rackspace and saying, help us with our cloud, help us build a cloud, give us your expertise, lend us your expertise."
So Rackspace is becoming a provider of support services, pushing aside sales of hosting products and services. Red Hat is proving the value of this model, but radical change is always difficult and often painful. And Rackspace saw a lot of that in 2013.