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  1. #1
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    [EN] Rackspace Struggling in Public Cloud

    Wall Street concerned that Rackspace’s partnerships with AWS and Microsoft might not offset public-cloud losses.

    "RAX is subscale in the cloud infrastructure as a service (public cloud) space"

    Tiernan Ray | Barrons
    February 17, 2016

    Shares of data center hosting firm Rackspace Hosting (RAX) are up 78 cents, over 4%, at $18.92, reversing yesterday’s after-hours drop of 8%, after the company reported Q4 revenue and profit that topped analysts’ expectations, but forecast this quarter’s, and the full year’s revenue, below consensus.

    The stock is moving up despite three downgrades this morning. The issue for the analysts is that although Rackspace has partnerships with Amazon.com (AMZN) and Microsoft (MSFT) for “public cloud,” the company may not be able to offset business lost to those two.

    Stifel Nicolaus’s Matthew Heinz cut his rating on the shares to Hold from Buy, and stripped away his price target of $30, writing that “despite the fact that shares are trading at six-year lows, we have waning confidence that upside catalysts will emerge in 2016, giving investors few reasons to own the stock here in our view.”

    Heinz zeros in on a slowing of revenue growth in “public” cloud computing:

    Given mgmt’s commentary around its managed hosting and OpenStack private cloud growth rates (high-single / high-teens respectively), we estimate a ~12% combined growth rate for the legacy “dedicated infrastructure” business. Applying this growth rate to the last disclosed segment breakout in 4Q14, we estimate that public cloud revenues decelerated from 30% to 10% growth in 2015 (~7% in 4Q15). We believe this was responsible for virtually all of the growth deceleration in 2015 (-540 bps), and based on the +8% midpoint for FY16 guidance we believe this implies a -7% contraction in public cloud revenues. Our prior expectation was for flat y/y growth in public cloud and 10% total revenue growth in 2016.

    Writes Heinz, while existing customers are “sticky” according to Rackspace management, and are not going away, nevertheless, “incremental workloads have been heading to AWS and Azure.”

    Also downgrading the stock is Pacific Crest’s Michael Bowen, who cuts his rating to Sector Weight from Overweight, as he’s skeptical the company can offset the leak of workloads to the public cloud providers:

    While Rackspace continues to attempt to win value-added contracts associated with other cloud platforms, the contracts are not material enough to offset softness in Rackspace’s public cloud revenue. Management states it is shifting resources from OpenStack private cloud to AWS and Azure as well, but this will likely take substantial time to accelerate [...] Rackspace reported that it now has 100 customers signed up on fanatical support for AWS and has its first estimated six-figure deal. The majority of these customers are new to Rackspace. While this may be a strong start for the company, it is not going to be enough to offset the weakness in the public cloud business, in our view. Rackspace cited macro pressures, 1Q16 softness, resources shifting to AWS and Azure, and its increasing reliance on cloud partners to drive value-added revenue. Rackspace decommissioned 2,400 servers during the quarter due to legacy public cloud migration to OpenStack public cloud and data center consolidation in London, and we believe decommissions could continue throughout 2016.

    Sitikantha Panigrahi with Credit Suisse cuts the stock to Neutral from Outperform, with a $22 price target, down from $50, writing that the company will continue to “experience challenges in (1) retaining its existing public cloud customers and (2) competing against existing AWS consulting partners (which include 1,288 partners and 46 premier consulting partners).”

    For the bull camp, Colby Synesael with Cowen & Co. reiterates an Outperform rating, while cutting his price target to $36 from $52. Synesael argues the cheap valuation of the stock offsets disappointing growth:

    We have been wrong to assume the company can maintain >10% growth and meaningfully reduced our PT to $36 from $52, but we maintain a constructive view considering the risk/reward at these levels is still highly attractive, while comments that the company added 100 new customers to its AWS support offer since its Oct. 6 launch, including its first >$100K/ mo customer, suggests to us that growth could reaccelerate in 2H16/2017.

    Update: The stock has gotten one upgrade this afternoon, from Shebly Seyrafi of FBN Securities, who raised his rating to Sector Perform from Underperform, with a $21 price target, writing that all of his fears have been realized:

    Our main bearish thesis since our downgrade to Underperform in May, 2013 had been that RAX is subscale in the cloud infrastructure as a service (public cloud) space, especially vs. AWS, and that the persistent price cuts that I expected (and have been realized) would result in either lower margins or lower revenue growth for RAX as the company cedes share. While both risks have realized (e.g. RAX had revenue growth of 28% Y/Y and Adj. EBITDA margin of 35% in F2012 vs. revenue growth of just 12% Y/Y and Adj. EBITDA margin of 34.2% in F2015), the revenue growth deceleration has been more notable. For F2016, RAX is now guiding for revenue growth of 9-10% Y/Y without Jungle Disk, an online file storage company which RAX divested, and FX, so RAX is expecting F2016 revenue growth to decelerate further. This had been one of our concerns as growth in recent “hard” metrics, like servers and headcount, have decelerated.

    However, the valuation is now “more compelling”:

    Shares of RAX are now trading at an EV/C2017 EBITDA ratio of ~3.5x, down from over 10x several years ago, and at a P/E of 14x on F2017. Although Wall Street uses RAX’s GAAP EPS for consensus calculations, the company’s NG EPS is much higher. For example, we model RAX’s F2017 NG EPS at $1.99, so the stock is trading at ~9x NG EPS that year, which we see as low for the company.


    http://blogs.barrons.com/techtraderd...-public-cloud/

  2. #2
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    Rackspace Still Running Out of Room

    By Richard Saintvilus | February 16, 2016

    Rackspace Hosting, Inc. (RAX) is running out of room, and possibly running out of time. Despite enjoying an early lead as a cloud infrastructure provider, the San Antonio-based company, having lost almost 64% of its value in the past 12 months and almost 70% in the past three years, has failed to capitalize on an industry it pioneered. In January alone, RAX stock got crushed to the tune of 20%, according to Capital IQ data.

    The company is scheduled to report fourth-quarter fiscal 2015 earnings results after the closing bell Tuesday. RAX shares closed Friday at $17.63, up 5.19%. But the shares are still down more than 30% year-to-date, against 8.77% decline in the S&P 500 (SPX) index. So while the stock does look cheap today at just 19 times trailing earnings, compared with a P/E of 21 for the S&P 500, it's gotten cheap for several reasons. And none of them are good.

    Expectations for the Quarter

    For the quarter that ended December, the average analyst earnings per share estimate calls for 23 cents per share on revenue of $521.39 million, translating to a year-over-year decline of 11.5%. Revenue is projected to rise 10.4%. For the full year, earnings are projected to rise 14% year over year to 88 cents per share, while revenue of $2.00 billion would mark a year-over-year increase of 11.4%.

    It's true, that both full-year revenue and earnings are projected to rise at double-digit rates. You would also be correct to point out that fiscal 2016 consensus estimates of 97 cents call for 10% earnings growth. The problem with RAX stock? There's just too much competition. The likes of Amazon.com, Inc. (AMZN) and Microsoft Corporation (MSFT) with big bank rolls have resorted to aggressively cutting their costs to grow their respective market share. (Read also, Overheated Expectations Send Rackspace Investors to the Torture Chamber.)

    Amazon and Microsoft are betting they can entice enterprise customers with low-priced services and then compel them to pay for higher-margin services. Given how price-sensitive business executives have become hoping to grow their own profit margins, this strategy has worked much to the dismay of smaller competitors like Rackspace. In that vein, while fiscal 2016 estimate calls for a 10% rise in EPS, notice it also marks a growth deceleration of four percentage points from 2015. And the years after aren't promising, either. ( See also, Rackspace Has Already Racked up a Demanding Valuation.)

    The Bottom Line

    To its credit, Rackspace still believes in itself, spending some $250 million buying back its own stock in the third quarter after upping its buyback authorization to $1 billion in the second quarter.

    While the company has promised to buy back at least $500 million worth of shares over the next three quarters, it won’t help the stock price given the rate at which large chunks are being dumped on the open market. To change negative investor sentiment, Rackspace must show prowess in competition, not financial engineering.

    http://www.investopedia.com/articles...t-room-rax.asp

  3. #3
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    Rackspace Earnings Report: Q4 2015 Conference Call Transcript


  4. #4
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    Taylor Rhodes (President): AWS

    The two leading public clouds, AWS and Azure, are seeing a new wave of these mainstream customers who want to use their infrastructure along with managed services. AWS and Microsoft don't want to disrupt their products' focus, so they are cultivating networks of managed service providers. We intend to become the biggest and the best of these and we're seeing strong direction toward that goal. Our top priority is to lead the AWS managed service provider ecosystem, letting AWS provide the economies of scale on its infrastructure, while we provide valuable economies of expertise.

    Let me share with you some of the characteristics of our AWS service from its launch on October 6 through the end of January. During its first four months our AWS team signed 100 customers, including what we expect to be our first six-figure a month enterprise customer.

    The majority of these customers are new to Rackspace. We believe that this is an encouraging indicator of our ability to win new market share. Most of these new customers are ones we could not have won without providing AWS support. Now that we've got them in the door, we believe that we can cross-sell to them our other offers, such as managed security, private clouds and data services.

    We are also actively selling Fanatical Support on AWS to existing Rackspace customers. Of these the large majority are bringing us new workloads. Through most of our history our installed base growth was driven by winning the first workload from a new customer, delighting it with Fanatical Support and then winning additional workloads.

    In recent years more of these incremental workloads have gone to AWS, contributing to our slowdown in growth. Now we're seeing encouraging signs that our multi-cloud portfolio can reignite that essential part of our growth engine.

    More than 1/3 of our AWS customers are international. We are actively leveraging AWS data centers and sales partnerships around the world and believe that we can now grow in a capital-light in regions where he previously had no physical presence.

    More than 70% of our AWS customers are choosing our highest service level, which we call Aviator. This trend indicates we are adding significant value on top of the AWS infrastructure. We add that value into ways: through the proprietary software tools that we have created to make the platform easier to use, and through the specialized expertise that we have built among our cloud engineers.

    We have now achieved more than 230 AWS technical certifications and more than 1,100 business and technical accreditations on AWS. We are also proud to report that we've recently achieved AWS certification as a dev-ops competency partner. These accomplishments place us among the top few AWS service providers in terms of expertise. They also demonstrate a long-standing strength of Rackspace, which is to rapidly create technical expertise at scale.

    The customers of our AWS service include market-leading companies such as Razorfish, one of the world's largest digital agencies. These customers also include one of the world's largest management consulting companies. Our sales pipeline is building nicely and we believe it's a good leading indicator of the growing demand for the expertise required to make the AWS Cloud run better.

  5. #5
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    Taylor Rhodes (President): OpenStack public cloud

    As we demonstrated in the second half of 2015 we can launch and fund new businesses, while also keeping margins in line with historical levels. One of our established products, our OpenStack public cloud, has a customer base that is sticky and continues to grow its spending with us; however, more and more new cloud workloads are heading towards AWS and Azure. Without those incremental workloads we expect the growth rate for our OpenStack public cloud to slow in 2016.

    At the same time now that we support AWS and Azure customers, we are in a good position to benefit from the growth in those clouds and this is where we will see rapid growth in our business. For that reason we're shifting engineering and marketing resources from our OpenStack public cloud to our new offers, including our OpenStack private cloud, which is growing in the high double digits.

    Several recent surveys of IT decision-makers show rapid growth in private cloud adoption, and particularly in the hosted Private Cloud model. For example RightScale's survey showed that 77% of companies are now adopting private clouds, up from 63% last year.

    Even as we shift resources toward our higher growth products we intend to continue to improve the reliability and performance of our OpenStack public cloud for the many customers who continue to use it. Many of those are hybrid customers who connect their public cloud environments to our dedicated servers.

    These hybrid users are among our stickiest and fastest-growing customers. With regards to guidance, Karl will provide the specifics, but let me give you a brief overview. For the full year of 2016 we expect revenue growth in the range of 6% to 10% on a constant currency basis after normalization to account for a small asset divestiture, which Karl will discuss. We believe this range is prudently conservative, and takes into account our expected Q1 softness, our lower expectations for growth in our OpenStack public cloud and the uncertain economic environment.

  6. #6
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    Taylor Rhodes (President): Fanatical Support

    We've had a managed cloud strategy in the market since mid-2014 and under that umbrella we want to make it very clear that if you are choosing one of the world's leading clouds, which in our mind is AWS, Azure an OpenStack for private clouds, then if you are a support seeker, then you should call Rackspace to run those and add value to those clouds.

    So you'll see our marketing content already in our first salt of the year in New York last week, on the website, other places start to rollout with that positioning around Fanatical Support for the world's leading clouds. We think that's a clear message, we want to be able to answer the question when should I call Rackspace, if you're trying to add value to the AWS, Azure or OpenStack private clouds you're getting out of your data center, you should call Rackspace.

    In terms of the revenue growth, looks it's early innings, right? We wanted to share lots of transparency with you all on the first 3-plus months of this offer. But that is 3-plus months, and I still I would echo the comment that says while we are encouraged on the traction we expect for these things to take some time to get to revenue levels that are big enough to move the $2 billion base.

    We'll update you along the way but I would say we're certainly encouraged by the early traction, by the sales pipeline build and we're seeing good demand. I mentioned AWS specifically because in listening to our shareholders that's where the main focus was, but I think it's also fair to comment that our Microsoft cloud business is off to a good start.

    Our sales initiatives around the cloud are seeing pipeline build led by Microsoft's private cloud, their Hyper V stack, and then followed up with Azure starting to build in the pipeline as well, and that sort of follows Microsoft's product roadmap in the market. You've seen them launch Azure stack, which is their combination of Private Cloud and public working together. So we're seeing good traction on the Microsoft cloud will business as well.

  7. #7
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    CapEx

    Heather Bellini (Analyst - Goldman Sachs): ... your CapEx guidance for this year, I guess I'm wondering because it does seem like you are pivoting to be a lot more of a managed services company. And if I look a lot of the other consulting firms that are out there, your CapEx levels are material lower even though you're having a big step down in CapEx in 2016 versus 2015. Why shouldn't your CapEx come way down and therefore really help free cash flow conversion going forward?

    I guess I'm a little confused as to what the aggressive spending on CapEx is for if the majority of what you're seeing is growth on other people's platforms?

    Taylor Rhodes (President): ... Remember that we are the number one managed hosting company in the world for dedicated hosting. And also we intended to be number one in private clouds because we seen an increasing buying cycle from particular verticals around that.

    That is an area where we deploy the capital, where we build the stack and own and control the stack, and where we've earned very good EBITDA margins and good ROIC. So there will be a part of our business that is on our capital, very sticky recurring subscription revenue models, and we will then marry that up with choice of the world's leading public cloud and operate that as a multi-cloud environment for our customers.

  8. #8
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    Losing incremental workloads

    Steve Milunovich (Analyst - UBS):

    A few summers ago you talked about the difference between managed and unmanaged cloud. And I think made the comment that if you and Amazon were in the same deal somebody was in the wrong place.

    And yet today you talk about obviously losing incremental workloads to them. So did that turn out to be a problem particularly in public cloud but not as much in managed and private? How should we think about that in retrospect?

    Taylor Rhodes (President): Steve, great question, thank you. I remember when we had that conversation.

    Look, I think as we've learned through this there's a couple things that have happened. One, yes it impacted our public cloud growth.

    We found that as Amazon really leverage their strengths which are pouring capital into their product, building their developer ecosystem, training people on APIs et cetera, they really picked up a lot of momentum that took public cloud apps further and further into their model, and that was a -- you've seen them right? They are a tornado. So we think that was an impact that was larger to our public cloud than we anticipated at the time.

    I think the second thing though is frankly now what we're seeing and hearing when we talk to really anybody who's deep in the market either through the professional services side or large customers who are thinking about what they are doing, the most important thing for us to consider is that whereas we were still in what I would call early adoption a couple of years ago, we are now firmly in central IT land where CIOs have caught up and saying we've got to go drive our businesses to the cloud, we've got to govern it, we've got to understand how to secure it, we've got to understand how to migrate applications et cetera.

    So what Amazon is seeing and Azure is seeing, and you can look at their actions to back this up, they are seeing the same hitting of that portion of the market. That's what they are working so hard on enabling the managed service broader ecosystems and putting so much of their efforts there. AWS and Azure sales reps who are trying to cover thousands of opportunities and the feedback we get is anecdotally. We don't have time to be here helping customers with the architecture with the cloud readiness assessment with the migration certainly and certainly with the ongoing operative, put SLAs on it.

    We think we've hit that part of the market where you are really seeing the managed service model and the managed service buyer show up at scale, and our intent on getting out of the data center and doing a data center shutdown. So to reiterate these are new offerings that we can benefit from and as AWS proves to be the predominant leader, we are seeing a lot of evidence that the big part of the market that wants to use their technology, that wants help doing is showing up.

  9. #9
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    cross-sell/upsell

    Jonathan Schildkraut (Analyst - Evercore ISI): You know, Taylor, you gave us really good color about AWS and wins around that business. I guess in our conversations we more and more hear how AWS is key for driving wins in sort of the other managed areas of the business, and you gave some good stats about six-figure customer mostly new. But could you give us a sense of whether these customers are also taking other services from you or if they are focused purely on the AWS support side of the business, and then a follow-up with some financial questions?

    Taylor Rhodes (President):

    Sure, I will caveat the answer is that the data we share with you is less than four months old so very early days. I think one of the things we are seeing though is that -- I'll give you an example, in addition to talking about AWS support many of these customers want to talk about managed security. We have developed an offer that allows the security posture from an application down into the infrastructure to be materially different and better than a customer has to manage complexity terms and cost terms on his or her own.

    A good example is being able to say we have built value around the AWS cloud in two ways, three ways really. One is through proprietary software development where if you go to our website you will see products like Compass and others that help customers manage things that are hard for them around the AWS cloud. That's software that makes the AWS cloud more valuable and easier to use.

    Second is the world has a scarcity of AWS experts. We have already as I mentioned gotten over 230 technical certifications which are very hard to achieve, and from our anecdotal evidence puts is already the very top. And we've already also earned over 1,100 business accreditations and technical accreditations around the AWS cloud so that our commercial people, our account managers et cetera, are fluent on the product so we're producing expertise at scale, which we believe will also be a huge advantage in this early nascent vulcanized managed service ecosystem.

    And the third is the cross-sell/upsell of additional products, so security is a great example. Early anecdotal evidence, but we're also seeing an interest in being able to leverage dedicated servers or bare-metal as a complement to the AWS cloud enabled through direct connect, as another example. So we actually have high ambitions and we hear feedback from the field that one of the differentiators is having this portfolio of option. So a lot of medium and large-sized enterprises view AWS as an amazing part of their cloud infrastructure, but it's a component of it, it's not the entire solution, and hence our commentary around multi-cloud buyers.

  10. #10
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    Data center commitments

    Jonathan Schildkraut (Analyst - Evercore ISI): Karl, you talked a little bit about transitioning some assets into the new London facility, and Taylor you talked about moving some folks off of the older infrastructure onto some of the newer options. I did notice the server count came down and I'm wondering if one or both of those things is tied to that reduction in the server count. But even as I think about that server count falling down -- not falling down but coming down -- it sort of begs the question around what's going on with your sort of power commitments, you guys are obviously committed to a significant amount of megawatts.

    You've launched about 90% of those megawatts but you're really only occupying about half, a number which has been somewhat consistent. And I'm just wondering if you have overcommitted on the data center side for what the business will look like in the future?

    Karl Pichler (CFO):

    Okay, so let me take that one.

    So the server count came down in Q4 mainly for the reasons that we've already talked about or least touched upon. There are two main reasons. One is we have still customers on our pre-OpenStack public cloud variation so to speak that we are actively migrating on now to the OpenStack control plane, which basically increases their features, makes it more attractive for them and allows us to really decommission gear that has reached its end-of-life.

    So we have decommissioned thousands of servers from old capacity pulls from pre-OpenStack cloud that have been quality depreciated. So that frees up not so much capital because they are fully depreciated but it certainly frees up power and data center space to be deployed again.

    The second thing that we more explicitly touched upon was the consolidation, so we had two facilities in the UK that we've decommission and migrated into London. That is the main reason why we had to take bigger capacity than we wanted. This is not a perfectly granular world where you can take half -- or quarter megawatt chunks. They come in certain minimal sizes and the UK situation it's two megawatts. So the marginal capacity step-up is two megawatts, and it comes in the those chunks.

    And so when we did the planning for the migrations and the initial pickup of what we have and the demand for dedicated and Private Cloud et cetera, we determined that the best way of proceeding here is to accelerate the second pickup and really decommission a little bit more than we want to facilitate all the migrations and consolidation.

    So we feel pretty good about that. Again we have a long-term expectation of growth that is related to dedicated and single tenancy and our own deployment, and so therefore we're not really concerned about our data center commitments at that point.

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