Rackspace Gets Some Breathing Room

NEW YORK (TheStreet) -- After a series of earnings disappointments, cloud giant Rackspace (RAX) is now back in the good graces of investors following its earnings beat Monday. Recall, Friday the stock closed at $26.28, down 1.35%. Shares had suffered a year-to-date decline of 33%. As of this writing, shares are now trading over $30, up more than 9%.

Before Monday's results, investors had a tough time understanding the company's position within the cloud. Rackspace, which competes with (among others) Amazon (AMZN) and Salesforce.com (CRM), had posted eroding profit margins and declining earnings within its cloud services. Management couldn't find the answer to reverse the trend. On Monday, the company delivered to investors some much-needed good news. 

First-quarter revenue surged 16% year over year to $421 million, beating estimate by less than half of 1%. The Street was looking for revenue of $419.53 million. The company was helped by strong demand in its installed server count, which grew 2.2% sequentially. Also helping revenue was the 1.1% uptick in average monthly revenue per server.

Earnings, meanwhile, rose 5% to 19 cents per share, which arrived in line with estimates. Earnings has been the problem affecting this stock. Even with the in-line result, it still represent a year-over-year decline almost 37%. Aside from Amazon, Rackspace has struggled against bigger rivals like Google (GOOG) and IBM (IBM), which has begun to apply pricing pressure in cloud computing services. 

The problem is that Rackspace has compiled a track record of aggressive growth, which has eaten more into the company's bottom line. Until recently, the Street has never cared. But as Amazon has begun to realize, profits do matter at some point.

From my vantage point, Rackspace was lacking in corporate customers willing to adopt its OpenStack, which Rackspace developed to become an industry standard. But unlike recent quarter, Rackspace management showed more confidence in the long-term with better-than-expected guidance. 

Looking ahead, with second-quarter revenue expected at $437 million, management set the midpoint of its revenue guidance just above Street targets. Analysts polled by Thomson Reuters had estimated revenue of $435.5 million.

Following the announcement, while praising the company's strong performance, Racksapce CEO Graham Weston suggested that the company added "thousands of new customers." Later in the statement is hinted that of the new customers added, one was "the largest we've ever landed."

There will be speculation as to who that customer is. But suffice it to say, this statement was enough to reignite interest in the stock. As I've said Monday, Racksapce is far from a terrible company. But its rise and fall underscores the consequence of "buying buzz," particularly in the tech sector.

The good news is that business conditions are improving and there are now signs that the company's recent struggles are on the mend. But it's still hard to forecast where this industry is heading, given that there are so many players. And I don't see how it makes sense to bet against Amazon and Google.

Rackspace has received some much-needed berating room. But the war for the cloud is far from over. 

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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