Rackspace Getting Squeezed by Competition Ahead of Earnings

Down 42% this year, Rackspace Hosting shares are still overpriced for a company losing ground to the cloud computing rivals that are out-executing it.
By Richard Saintvilus ,

Cloud computing specialist Rackspace Hosting (RAX) will report third-quarter fiscal 2015 earnings results after the closing bell Monday. Owing to increased competition from the likes of Alphabet (GOOGL) - Get Report -- better known as Google -- and Amazon (AMZN) - Get Report , Rackspace is seemingly running out of room.

Rackspace's struggles to grow revenue and profits were highlighted in our last discussion on Aug. 7, when we advised selling the stock. At the time, the shares traded at around $32. Since that day, they've fallen almost 20% to around $26. All told, RAX shares have plummeted some 42% so far in 2015 and 27% over the past 12 months. If you've been holding RAX stock for the past three years, you're likely in the hole around 60%.

And here's the thing: Even after the stock's decline, the shares -- trading at a price-to-earnings ratio of 32 -- are still expensive. That's 11 points higher than the P/E of 21 for the S&P 500 (SPX) index. Plus, when looking ahead to 2016, RAX stock is priced at a forward P/E of 26, based on consensus estimates of $1.01 a share. Not only is that estimate 8% lower than where it was at the start of the quarter, that forward P/E estimate is nine points higher than the ratio for the S&P 500.

It would seem, therefore, that the San Antonio-based company is being priced for high growth, and it's true, cloud computing remains a high-growth industry. The success of Salesforce.com (CRM) - Get Report , whose shares are up 31% in 2015 and 120% in three years, serves as evidence. But unlike Salesforce, Rackspace has missed Wall Street's revenue projections in three straight quarters. During that span, two of its earnings results were merely in-line with consensus estimates.

Revenue misses and in-line earnings don't justify a high P/E. What's more, based on the company's own sequential revenue growth target range of 2% to 3.5%, it would seem Rackspace is sending the message that expectations have been too high. And with the company's decision last quarter to stop breaking out individual performances of its cloud (Web hosting) and public cloud (IaaS) revenue, investors should pay attention to what's implied by this new lack of transparency.

From my vantage point, it would seem Rackspace is losing share in its bread-and-butter businesses. And this has been the case for a while. Consider, Rackspace is projected to grow fiscal 2015 revenue at 11% year-over-year. Not only would this equate to a revenue growth rate half that of rival Salesforce.com, Rackspace is projected to grow earnings per share at one-fifth the projected earnings growth rate of Salesforce (8% vs. 40%).

All cloud computing stocks are not the same. Even amid a thriving industry, execution is still the key to success. For Rackspace, absent better execution, the stock will continue to struggle and investors should stay away.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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