A very modest miss of analyst revenue estimates has cost Rackspace (NYSE:RAX) dearly. The company quarterly results fell short of analyst estimates by $2.54 million, or less than 1% of its quarterly revenue target. The punishment that RAX endured as a result of this miss could only be described as brutal. From its pre-announcement level of around $75 per share Rackspace stock fell in two days of trading to just below $60 - a loss of over $2Billion in market value. For every dollar that Rackspace revenue missed the Street estimate, it has so far lost over $800 in market cap - an 800-to-1 punishment. As a reminder, Rackspace typically trades in a multiple range of 7X to 9X revenue. So what is behind the sell-off, is it an over-reaction and when will it stop?
RAX was clearly priced for perfection, - a momentum story and a trend stock that could only stay at its hefty levels if it not only met but consistently exceeded analyst estimates and raised guidance if available. At around $59 the shares are trading at an intermediate support level. If the shares make a break below $59, - more downside is possible. At the same time, we continue to see the momentum in cloud computing as strong and accelerating. The long term trend remains in place and is broadening outside the base of early adopters. Rackspace continues to be cited by IT buyers and competitors as one of the Top 3 suppliers of cloud computing infrastructure services. Its service levels are praised and pricing levels are often subjected to criticism - a sign that the company is able to maintain its margins against a perception (misguided in our view) that there seems to be an onslaught of near infinite capacity of cheap computing power. One of the consistent inputs we hear from the field is that many customers use Amazon Web Services for development, but for production often chose Rackspace regardless of price.
Where we do see a challenge for Rackspace and other providers of cloud services, components and tools is that the very broadening of the appeal of cloud computing may actually create a temporary slow down in the sales momentum. The focus of the market is shifting away from early adopters to a much more mainstream set of buyers who take longer to buy, run longer trials and negotiate much harder on price and service levels. This transition is a process, not an event and will create a temporary damping effect in the cloud space. So far, during the recent earnings announcement season, we have seen a number of pure play and component suppliers in the cloud space stumble and see their stocks punished severely. VMware, Riverbed and CenturyLink are all examples of recently disappointing results.
In the near to mid-term Rackspace may see a moderation of its multiple. We do not see the company going the way of Blackberry but investor caution will be more pronounced as the company and some of its key competitors, suppliers and partners wade through this near term period of buyer transition.
Note: The preceding is not an offering or a recommendation to buy or sell securities of any kind. Rackspace, VMware, Riverbed and Centurylink are components of the MGI Cloud30 Index.
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