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Rackspace Plunges: What Wall Street's Thinking

Stocks in this article: RAXAMZNGOOGMSFT

Updated from 12:31 p.m. to include thoughts from FBN analyst.

NEW YORK (TheStreet) -- Rackspace (RAX) shares plunged in early Tuesday trading, falling 18.1% to $33.03 after the cloud computing company posted exceptionally weak fourth-quarter results and announced the departure of CEO Lanham Napier.

For the fourth quarter, San Antonio-based Rackspace earned 14 cents a share on $408 million in revenue, up 16% year over year. Analysts surveyed by Thomson Reuters were looking for 14 cents a share on sales of $404 million.

For the quarter, Rackspace's total server count increased to 103,886, up 2% sequentially.

RAX ChartRAX data by YCharts

Despite the in-line report, Rackspace announced that CEO and board member Napier had retired, as he looks to move into other investment opportunities. Co-founder and executive chairman Graham Weston will become CEO.

"My decision to step down as CEO was a difficult one, but it's the right choice for me and for the company. With the board and management team aligned around our 2014 strategy and financial plan, I believe now is a natural transition point to select a new leader for the next exciting phase of Rackspace's growth," said Napier in a statement.

Weston noted Rackspace would start to focus on the hybrid cloud, as the company attempts to differentiate itself from its competitors, including Amazon (AMZN), Google (GOOG), Microsoft (MSFT)and others, as the environment becomes more competitive on pricing. "In 2014, we will take the next step to carve out our differentiated position and help the next adoption wave of customers reach a hybrid cloud world. We will continue to invest in our portfolio of services and reinforce our differentiation in the market. We will win as we always have one delighted customer at a time," Weston said in a statement.

Despite the better-than-expected revenue, most analysts on Wall Street were lowering their price targets, citing the uncertainty around the CEO leaving and the competitive environment. Here's what a few of them had to say:

Jefferies analyst Mike McCormack (Hold, $35 PT)

"RAX delivered better than expected headline results, benefiting from FX tailwinds. With guidance largely in-line with expectations, and implying limited growth acceleration, the quarter failed to deliver a turn-around that bulls have been waiting for. Given the uncertainty of the growth profile, we maintain our Hold rating, but lower our year-end 2014 price target to $35."

UBS analyst Steven Milunovich (Neutral, $38 PT)

"Rackspace's strategy is to sell to 'pragmatic' customers that value Fanatical Support and are attracted to Open Stack for hybrid cloud. Management argues that early public cloud users are more do-it-yourselfers but that the next wave will be mainstream companies that will want Rackspace's higher level of service. This is the critical issue- will RAX be able to differentiate even against the likes of IBM and VMware in hybrid cloud or will CIOs be attracted by lower prices than RAX is willing to offer?"

Canaccord Genuity analyst Greg Miller (Hold, $39 PT)

"Despite a solid Q4/13 report and initial 2014 guidance that are largely in line with expectations, we believe the surprising decision by the CEO to retire will likely create uncertainties in the stock. Following a year of tougher-than-expected OpenStack rollout and given the increasing level of competition in the cloud market, we believe the change in top
management team will likely undermine investor confidence in its ability to achieve its 2014 objectives. We maintain our HOLD rating and lower our price target from $42 to $39, which is based on 8.5x 2015E EBITDA."

Credit Suisse analyst Sitikantha Panigrahi (Outperform, $49 PT)

"We believe that the next phase of cloud growth will be driven by hybrid cloud adoption by enterprises. In our view, Rackspace is well positioned to benefit from secular growth trends in cloud, and the company can carve out a niche with its differentiated cloud offerings based on performance, 'fanatical support,' and OpenStack-based open cloud. We reiterate
our Outperform rating and price target of $49, which implies NTM EV/EBITDA multiple of 8.2x."

JPMorgan analyst Sterling Auty (Overweight)

"The first step in the re-acceleration of Rackspace is complete with Managed Hosting showing faster y/y growth in December as compared to September. That is a quarter earlier than we forecasted. The second step is to see total revenue growth improve year-over-year which we are now forecasting for March, and the final step is cloud revenue, so that all the pieces are accelerating and we believe that will start in June."

Oppenheimer analyst Timothy Horan (Outperform, $62 PT)

"Revenue/EBITDA were above our estimates, driven by steady growth in Public Cloud and a solid rebound in Managed Hosting. Guidance was solid as the full-year outlook (introduced for first time) was in line, although the 1Q guide was softer than expected. The key issue near-term will be speculation around the surprising departure of Lanham Napier, Rackspace's CEO. That said, fundamentals and trends at RAX are improving and the difficult transition to hybrid/public cloud is well underway. We think a pullback to the low-mid-$30s (7-8x FY14E EBITDA) represents an attractive buying opportunity, particularly given that a management change is a perfect time for an acquirer to step in and enterprise cloud adoption is accelerating."

Pacific Crest Securities analyst Michael Bowen (Sector Perform, No PT)

"As we anticipated, Rackspace's results and guidance were not strong enough to silence questions concerning competition from Amazon Web Services and other Cloud services providers. In addition, the company now is contending with a CEO search/change, and could take several quarters to find a replacement. We believe it is too early to buy shares until the company can demonstrate consistent growth in enterprise contact wins and accelerating sequential revenue growth rates."

FBN analyst Shebly Seyrafi (Underperform, $35 PT)

"We retain our Underperform rating on RAX and lower our PT from $42 to $35. RAX reported a slight revenue beat with in-line EPS as GM was a bit light while S&M and depreciation were a bit heavy. Moreover, with the retirement of prior CEO Lanham Napier (replaced by Graham Weston, Chairman and interim CEO; Mr. Weston, a co-founder, was CEO from 1999-2006), we think that uncertainty at the company has increased. This, together with increased competition from AMZN's AWS, IBM, and now GOOG cause us to retain our negative stance toward the equity. RAX is emphasizing fanatical support, hybrid cloud, and OpenStack, but we question whether this strategy creates a durable moat considering the aggressive competitors that it is facing."

--Written by Chris Ciaccia in New York

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