Rackspace (NYSE: RAX), one of the largest providers of data center services, announced its Q3 2013 results yesterday (Nov 11) after market close. The quarter saw sequential as well as Y/Y growth in revenues of the hosting company. However the profit margins of the company took a significant dip as the operating expenses grew faster than the revenues. Karl Pichler, CFO, SVP and Treasurer of Rackspace hosting did talk about the increasing expenses. He said ‘Consistent with our goal to reaccelerate revenue growth, our decision to invest aggressively in hiring technical talent and in research and development have depressed margins this year compared to 2011 and 2012’ indicating that the drop in margins was not something to worry about. However Karl failed to convince the investors as the earnings announcement was followed by an 8% drop in the stock price in after-hours trade.
Rackspace Q3 2013 financial performance
The only positive from the quarter was a 15.7% growth in revenues on a Y/Y basis. The revenue growth was accompanied by a severe hit to the profit margins of the company. The operating margins saw a fall of 6.35% reducing to nearly half of the year ago operating margins accompanied by a drop in the absolute operating profit numbers. The total operating expenses increased by 24.2% on a Y/Y basis negating the 15.7% growth in net revenues. Research and development costs increased by a whopping 50% on a Y/Y basis, selling expenses by over 18%, G&A (general and administrative) increased by close to 20% leading to the steep jump in operating expenses. The non-GAAP measure of adjusted EBITDA margin also saw a fall of 4% compared to the year ago margins. One fact which will worry investors is that the margins of the company have seen a decline over the last three quarters on a sequential basis accompanied by a slow-down in revenue growth. The table below shows the key financial metrics of Rackspace for Q3 2013.
The quarterly performance had very little to cheer about for investors where as reasons for causing worry were many in number.
Actual performance v/s analyst estimates
The actual EPS for the quarter fell short of the consensus analyst estimate. The analyst consensus estimate, according to streetinsider.com, was at 16 cents whereas the company reported an EPS of 11 cents, missing the estimates by over 30%. The revenue of $ 388.6 million was marginally ahead of the consensus estimate at $387.5 million. Although the company did beat the revenue expectations, the steep increase in operating expenses outpaced and negated the topline growth, leading to a fall in earnings and a lower than expected EPS.
Though the management seemed pretty optimistic about the future, the quarterly performance has failed to impress us at Amigobulls. We view Rackspace a risky bet considering the trend of slowing growth and falling margins. Consider that against the stock’s current valuation levels and the risk assumes huge proportions. The stock is currently trading at a price to earnings (P/S) multiple close to 70, making it a very risky investment considering the current fundamentals of the company.
To see Rackspace’s latest stock price movement, click here (NYSE: RAX)