I have been studying Rackspace (RAX) for a while and it seems like an interesting opportunity.
What they do:
They are a cloud computing company that provides different services to other IT outfits. They are kind of like a rental service for servers on the Internet. Instead of buying the server and having it shipped to you they host it at their site and you connect to it via a browser. They also offer higher end stuff like managed hosting and private cloud services so that companies can virtualize their IT environment.
What they have going for them:
They seem to be growing like a weed with 24.1% annual revenue growth and 42.8% net income growth per year. They are in a sweet spot of cloud computing which is supposed to be growing like crazy according to some sources I have seen. This site says by 2012, customers are expected to spend $42 billion on cloud computing. This is all basically from almost nothing just a few years ago.
Imagine how much companies will be spending in 2020 when we expect to create 35 Zettabytes of data. A Zettabyte is 1 billion terabytes. You can store about 1000 movies in a 1 terabyte drive so you can do the math on how much capacity needs to be created to cover this demand. So cloud computing might be one of the few ways a company can add capacity without building entire server farms for their data.
So the potential market they are in is big and they also provide 24/7 support by email, phone, and IM chatting. This is their so-called Fanatical Support. I think support is very important when you are trying to do something like virtualizing a data center so this might be quite a built-in advantage over someone like Amazon EC2 which charges $400 for their support.
They don't have much debt with $169 million which is a little more then the amount of cash that they have on their books. I kind of like them to have none since most high-tech firms have zero but they seem to be expanding as fast as they can. They are even hiring executives from other high tech firms like Ebay. They seem to have an eye on international expansion as well. Their execs seem to be buying the stock like crazy as well to the tune of 18 million shares.
There is also consolidation in their industry with their competitor 3Par in a bidding war between HP and Dell. Both companies wanted to pump up their margins and get more into the service field and not just sell printers and PCs. Buying a growing company (at what some people believe is an inflated price) that already owns the infrastructure and software to enable cloud computing is far superior than trying to build something themselves. I wouldn't be surprised to see some other high tech behemoth like Dell, Oracle, or SAP to come sniffing around Rackspace looking to make a deal.
Things that are Against Them:
They are trading at an 80 P/E which is phenomenally high even for a company growing as fast as they are. Their competitors are Amazon and Google two of the largest and most powerful tech firms out there. Those two companies are trading at a 62 P/E and a 22 P/E respectively. So with a P/E that high any stumble will smack the stock. It seems other investors think the same way because the short interest is at 33% of float.
You also have the headwind that some companies might not want to expand right now and would rather hold on to their cash. This could slow Rackspaces' revenue growth at the time that they are shelling out big bucks to expand. However, these companies can't wait forever since their data and server needs will grow as fast as they hope to.
Bottom Line:
I think the stock is kind of pricey here and would be a good buy at some sort of pullback to about $20 - $21. However, you will be paying for a company that is in a very sweet spot and is growing like crazy so the premium might be worth it in the long run.
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