Rackspace Needs to Find Its Rhythm

However, a closer look at Rackspace reveals some vulnerabilities, starting with a nagging persistence of deteriorating margins, and continuing with a history of outages that have plagued Rackspace in the past year.

Rackspace's path to the public markets hasn't been a smooth one. It's gone through four CFOs in five years, according to the San Antonio Express-News, and disclosed a "material weakness" in its 2007 accounting. It also withdrew its IPO proposal during torrid markets last March.

Investors who can stomach those warning signs may want to take a hard look at profit margins. The company has seen its profit growing more slowly than revenue. The company's top line grew 62% last year from 2006, while operating profit grew 20% and net profit declined 10% (mostly because of a surge in interest expenses and revenue lost due to outages).

That trend hasn't changed much this year: In the six months through June 30, Rackspace's revenue grew 57%, compared to operating profit growth of 23% and net profit growth of 7%.

Rackspace's Margin

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This graph shows how the slower profit growth is eating away at margins over the past couple of years. Net margins have been below 5% for the last three quarters, and operating margins below 10% for five of the past six quarters.

The overall margin trend is clearly downward. In the June quarter, operating margin fell to 6.4% from 9.3% in the year-ago quarter, and net margin fell to 3.2% from 5.7%.