Bear of the Day: Rackspace (RAX)

by

April 23, 2013 |

The frontiers of technology are full of great new innovations that quickly become commodities. The so-called cloud revolution for data storage and software application usage may soon have its own "commodity moment" for firms competing to win and sustain business.

And one company currently experiencing the pain of pricing pressures is Rackspace Hosting (RAX - Snapshot Report), a leading provider of hosting services in which the company provides IT infrastructure and management for customers' Websites, applications, and other computing needs through its data centers and cloud services.

RAX slipped to Zacks Rank #4 (Sell) and then a Rank #5 (Strong Sell) last week after analysts continued to lower earnings estimates. Full year 2013 profit projections have been taken down by over 11% in the past two months since the company's last quarterly report on February 12.

The impetus for the downward revisions has been Rackspace's announced pricing changes for certain cloud services, including a 33% reduction in the price for cloud bandwidth/CDN services and the introduction of tiered pricing for its object storage service that equates to volume discounts.

Here' the Zacks proprietary Price & Consensus chart which tracks annual estimate changes and plots them against the stock price.

Expectations Coming Down from the Clouds

Last week also brought price concessions from a bigger name in the cloud space. Microsoft (MSFT - Analyst Report) recently announced its decision to slash prices for its Windows Azure cloud services as part of an effort to better compete with Amazon's (AMZN - Analyst Report) cloud computing platform.

The decision to slash prices by 21% to 33% for some of its online data services will help Microsoft to match the prices offered by Amazon Web Services (AWS). Once again, it appears that Amazon can develop strong new revenue streams in new business areas by being the lowest cost provider that everyone else must compete with.

The news from these behemoths was definitely a factor in the analyst moves on RAX, as several have shifted to a "hold" rating on the stock. Here's what one prominent Wall Street house wrote last week...

"We are reducing our estimates to reflect more conservative cloud revenue growth assumptions. We believe recent pricing changes for certain cloud services will likely result in near-term growth headwinds on that side of the business (~25% of revenue)."

Bottom line: Though the decline in RAX has been very steep, dropping the stock 40% from $75 to $45 in only 10 weeks, some investors may still consider it a falling knife with its current growth outlook. With a forward P/E near 50X, this is one that could still fall further if its earnings visibility only gets cloudier.

Kevin Cook is a Senior Stock Strategist with Zacks.com

Email Print Share Rate Pos Rate Neg