Sell Rackspace Ahead of Earnings

NEW YORK (TheStreet) -- Shares of cloud giant Rackspace (RAX) remain under pressure following a succession of earnings disappointments. The stock is trading at $27.35, down over 30% for the year to date and 32% for the past 52 weeks.

When compared to Amazon's (AMZN) 28% year-to-date decline, Rackspace's punishment may not seem like a big deal. But expand the range a bit wider, Rackspace stock have plummeted close to 70% over the past 16 months. Part of the lack of confidence in Rackspace has been the effect of struggles seen in Amazon's own Web Services segment.

The idea is that since Amazon, which is the leader is web/cloud services is suffering, the outlook for Rackspace must not be good. Unfortunately, Rackspace, which has posted eroding profit margins and declining earnings within its cloud services, has proven this theory correct. Until management is able to reverse this trend, the stock will remain in a free fall.

On Monday after the close, the San Antonio-based company will report first-quarter earnings results. The Street will be looking for earnings of 12 cents per share on revenue of $419.53 million, which would represent a 16% year-over-year revenue increase.

Earnings -- which has been the problem affecting this stock -- is projected to decline almost 37% year over year. As with rival Salesforce.com (CRM), Rackspace has compiled a track record of aggressive growth. The concern has been the costs associated with that growth. Until recently, the Street has never cared. But as Amazon has begun to realize, profits do matter at some point. This is where Rackspace management must deliver.

On Monday's conference call, in addition to concerns about profitability, management has to address what I have noticed as an obvious lack of confidence in its own stock. CEO Napier Lanham has sold well over 1.6 million shares since November at around $42 per share. Other officers of the company have sold as well.

I'm not suggesting Lanham is bailing on the company. He still controls roughly 4.5 million shares between his personal holdings and as a partner in a private enterprise. But I can't overlook how well-timed these sells were. He deserves credit.

Racksapce is far from a terrible company. But its rise and fall underscores the consequence of "buying buzz," particularly in the tech sector. The stock soared when the entire market inflated the valuations of everything associated with the cloud. But the thrill is gone.

Don't underestimate the resolve of Amazon. CEO Jeff Bezos is not going to remain down forever. With the market demanding a cloud leader, Amazon is motivated to squeeze out rivals like Rackspace that threaten its territory. So buying or holding the stock here assumes that things won't get worse.

Until then, Rackspace investors are likely stuck in no-man's land. It's possible that this 70% 16-month decline is an overreaction. It's also possible that it's just the beginning of a longer trend.

If you've been holding the stock and feel strongly about the company's long-term prospects, a good strategy would be to dollar-cost-average down. But you have to also assess the risk in being wrong.

From my vantage point, until management can put together consecutive quarters of earnings/margin improvements, invests have to avoid this stock.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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