Rackspace: What If Expected Profit Surge Isn't So Awesome?

YCharts

Shareholders of cloud provider Rackspace Hosting (RAX) must be wondering what’s happening to their golden stock, which has been knocked back some 32% since the company reported earnings Feb. 12. How can a 25% revenue gain and 19% net income rise year-over-year do the kind of damage see in a stock chart?

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RAX Chart

Of course the market expected more. And when your shares trade at enormous PE ratio and sales valuations as seen in the chart below, an earnings miss can quickly make investors wonder whether the stock has been irrationally inflated on dotcom-like fantasies.

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RAX EV / EBITDA TTM Chart

By most measures, Rackspace’s business is a healthy one. It has become Amazon’s (AMZN) chief competitor for cloud services, which companies buy to store their information on remote servers. Although competition in this business is fierce, Rackspace has steadily improved its profit margins. Investors that bought in shortly after its 2008 IPO saw their shares return ten times their investment before this year’s slide. They’re still up some 660% since then.

Investors expect much higher earnings in the future, when they believe capital expenditures will decline. Right now, though, the company is investing heavily in things like research, servers and real estate. Rackspace’s operating expenses still far outstrip its cash from operations.

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RAX Cash from Operations TTM Chart

Investors assume that its earnings will soar once this spending need eases. Some industry analysts say they are expecting too much in future earnings. Two industry analysts initiated coverage of Rackspace last month; one with an underperform rating, and a second with a sector perform. Numerous analysts still recommend the shares, but there are more holds on them.

There’s always the possible that one of Rackspace’s bigger competitors, like International Business Machines (IBM) or AT&T (NYSE:T), will buy the company. Rumors that someone is interested in a takeover of Rackspace pop up often. Then somebody looks up the valuations on Rackspace shares, and that talk dies off pretty quickly.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.


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