I have to admit, Rackspace Hosting (NYSE:RAX) is nothing if not reliable. The company has been able to keep a loyal base of customers in a crowded data-center hosting market. (Its competitors include everyone from major telcos such as AT&T (NYSE:T) and Verizon (NYSE:VZ), to IT services giants like IBM (NYSE:IBM) and HP (NYSE:HPQ), and even Amazon.com's (NASDAQ:AMZN) EC2 platform.) This success is largely due to its reputation for good, reliable service. 

Likewise, the company has been keeping investors happy by delivering reliable growth in the midst of a recession that's made such a trend harder to find. And as Tim Beyers pointed out yesterday, Rackspace's earnings release on Monday did nothing to change that story -- while revenue growth remained down from pre-recession levels, it still came in at a healthy 17%.

Unfortunately, earnings don't look anywhere as solid. With adjusted earnings per share coming in at $0.06 for the quarter (a penny below estimates) and amounting to $0.23/share for the last 12 months, the company has a trailing P/E of 81. If the company hits the consensus estimate of $0.38/share for 2010, its P/E will come down to a "mere" 49.

Of course, you can make the case that, for a business as capital-intensive as server hosting, earnings aren't as good a metric for judging a company as free cash flow. But for Rackspace, the cash flow picture doesn't look too pretty either. The company stated that its "adjusted free cash flow" for the quarter was a mere $10.6 million -- nothing to brag about for a firm with an enterprise value of roughly $2.2 billion. And if you use the conventional approach of defining free cash flow as a company's operating cash flow minus its capital expenditures, Rackspace was actually in the red by $4.3 million.

The reason Rackspace is having trouble generating healthy cash flow is pretty simple: It can't keep capital expenditures under control. Consider this another "reliable" part of the business. Having already increased its 2009 capex forecast from $140 million to $175 million in the prior quarter, the company has raised it again, to $185 million. Based on 2009 revenue forecasts, that number should approach a full 30% of sales. As a reference, telecom industry capex levels are traditionally in the 15% to 20% range.

What makes Rackspace's numbers especially troubling is the nature of its business model. If a huge chunk of Rackspace's capital expenditures were tied to building new data centers used to host third-party equipment, as is the case with rival independent hosting firms such as Equinix (NASDAQ:EQIX), I could see capex quickly declining once the data centers are built out. But instead, Rackspace is spending a small percentage of its capex on data-center investments, since it leases space from third parties; the bulk of capex goes to hardware and software, which it uses to offer hosted services.

Since IT gear tends to depreciate in value pretty quickly, you can count on these investments amounting to a large chunk of Rackspace's revenues for the forseeable future, and keeping down earnings and free cash flow along the way. And if data-center leasing costs take off, the company's cash flow statement will see another major headwind.

With plenty of happy customers and a trend toward hosted IT services that isn't going away, I can see Rackspace delivering double-digit revenue growth for quite some time. But with the company's capital spending needs being what they are, transforming from a growth story to a cash king will be a much harder task.