Rackspace Cut By Analysts On Poor Outlook, Strong Competition

Shares of Rackspace Hosting, Inc. (NYSE: RAX) touched a 52-week low after the cloud service company guided slower revenue growth for 2016 despite reporting better-than-expected fourth quarter results. The development led to a series of analyst downgrades on the stock, which fell 17 percent on Wednesday and 65 percent in the last one year.

For the first quarter of 2016, Rackspace expects revenue to be between $517 million and $521 million, below analysts' estimates of $528.9 million. Rackspace expects full-year revenue to be between $2.08 billion and $2.16 billion, which also fell short of analysts' consensus estimate of $2.21 billion.

However, shares traded recently at $18.46, up 1.5 percent.

Tepid macro economic conditions, softness in first quarter, strong competition from bigger players such as Amazon.com, Inc. (NASDAQ: AMZN)'s AWS and Microsoft Corporation (NASDAQ: MSFT)'s Azure is weighing on the company's fundamentals. Amazon Web Services remains the market leader with more than 70 percent growth a year. On the other hand, Google, HP, IBM and Microsoft are increasing their cloud capabilities. Several other open source cloud platforms, including CloudStack, compete with OpenStack as a future standard.

Weak Growth

Pacific Crest Securities downgraded Rackspace to Sector Weight from Overweight, citing that the growth will likely remain weak in 2016 and recovery scenario is uncertain.

Analyst Michael Bowen said, "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 decommissioned 2,400 servers during the quarter due to legacy public cloud migration to OpenStack public cloud and data center consolidation in London. The company believes it can offset some of the weakness in its own public cloud, and retain a majority of these customers, by helping these customers move to other public cloud providers and then providing managed services for these companies. But Bowen thinks other otherwise.

"We are more skeptical and, somewhat like the company's predicted ability to manage the weakness in the public cloud segment, we believe the company may be overestimating its ability to retain its customers," Bowen said in a note to clients. He added that the lack of near-term catalysts for growth, in a cloud sector marked by growth, will likely result in continued weakness in the shares despite an aggressive buyback program.

Morgan Stanley's Simon Flannery also noted that Rackspace's own Openstack cloud growth continues to slow as the result of lower incremental sales. In order to capture the benefits of the service-only model, 2016 is once again a transitional year for Rackspace, starting with an ongoing reorganization of the sales and marketing team.

In addition, Barclays cut Rackspace to Equal-Weight from Overweight and slashed its price target to $21 from $35.

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