SAN FRANCISCO -- Rackspace Hosting (RAX) lost ground on its debut trading day Friday.

The tech IPO priced late Thursday at $12.50, but opened the session below $10 before climbing to $11.08 by the end of its first hour.

The offering of 15 million shares by the San Antonio, Texas, Web hosting company, which priced at the low end of its stated range of $12 to $16, raised $187.5 million in a modified Dutch auction.

During the past six weeks, first-day performance for new issues "has been dismal," said Ben Holmes, analyst at MorningNotes. "Deals that we thought had an audience absolutely melted down."

GT Solarone of the few recent tech IPOs, came to market at $16.50 on July 24 and ended its first trading day down 12% at $14.59, according to MorningNotes. It was trading recently at $12.05.

Banks put a lid on chatter Thursday as to how the issue was shaping up, giving analysts' little insight into the rationale for the ultimate offer price. "We don't know if the low price is a sign of weakness or generosity," Holmes said before trading began Friday. "We hope it was a choice to price it at $12.50 -- a gesture to make the deal work, pricing it cheap to put some pop into it."

But the low initial trading price likely shows demand was low for the issue. The troubled economy has drastically weakened IPO demand, with new issues including some from China, performing poorly, Holmes said.

"Rackspace is a solid company, solid grower, with respectable growth. They are disciplined users of capital. In a good market, we'd be climbing over each others' backs for this thing," Holmes said.

Analysts had expected a relatively warm response to the new issue, but Rackspace faces tough competition in its attempt to produce long-term growth.

Early investors in Rackspace include venture firms Sequoia Capital and Norwest Venture Partners, which did not sell shares yesterday.

Linux software developer Red Hat ( RHT), which invested in the company in 2007, sold 26% of its stake of 1.9 million shares in the IPO.

Rackspace's revenue for the first quarter of 2008 jumped 59% year over year to $119.6 million, comparable to its annual growth rate in each of the past three years. Revenue in 2007 grew 62% to $362 million.

Gartner analyst Lydia Leong estimates the U.S. market for Web hosting, which typically involves providing server space for companies' external Internet sites, will grow at a compound annual rate of 19% through 2012. The U.S. market is expected to rake in $10.6 billion in 2008.

The company's hosting competitors include Savvis ( SVVS), AT&T ( T - Get Report) and Terremark among others.

"Rackspace is growing three to four times the rate of the Web-hosting market as a whole, because they offer a differentiated service experience," Leong says. "To scale a service business growing at the rate they are is a tremendous challenge."

Rackspace also competes in the emerging "cloud-computing" market, in which companies such as Amazon, IBM ( IBM - Get Report) and Microsoft ( MSFT - Get Report) will let corporate clients to transfer their internal software applications to data centers run by these tech giants.

From a virtually nonexistent market today, "we expect to see the majority of corporate IT infrastructure move into the cloud" over the next two decades, Leong says.

The changing dynamics of the Web-hosting-to-cloud-computing market could spell longer-term trouble for Rackspace, unless it can buy or build and integrate a broad portfolio of business software, says David Tapper, vice president of outsourcing research at IDC.

As a Web host, Rackspace's business model is caught between on-demand software-hosting companies like Salesforce.com ( CRM - Get Report) and the tech-savvy behemoths, Tapper says.

Those tech giants represent "major competition, no question about it," Tapper says. "You have to have global reach, scale and the ability to integrate applications to meet the needs of corporations.

The giants will provide a broad portfolio of their hosted software and services to clients, as will application-specific companies like Salesforce. The IBMs and Amazons are scaling up by building massive data centers worldwide.

On the other hand, Rackspace will be squeezed toward smaller clients, as it lacks the international data centers and scale of, say, IBM, Tapper says. Mid-market companies want their hosts to provide an extremely broad portfolio of sophisticated, integrated business software, he adds.

"A key element of our growth strategy is to further expand our customer base internationally and successfully operate data centers in foreign markets," Rackspace's prospectus states. "We have limited experience operating in foreign jurisdictions and expect to rapidly grow our international operations."

Citing business failures that stemmed from an inability to meet demand quickly, Tapper says he expects Rackspace to be challenged to ramp up fast enough in the face of such deep-pocketed competitors.

But even the tech giants will have their own challenges: They don't have recognizable brand names for their cloud-center services, Tapper says. Rackspace already has that, he added.