Rackspace's first quarter earnings conference call featured CEO Lanham Napier, talk of a slow start to the year and a massive elephant in the room: Amazon Web Services.
The company reported first quarter earnings of $27 million on revenue of $362 million, up 20 percent from a year ago. The problem: Wall Street was looking for sales of $366.7 million. Rackspace acknowledged that it has to get its growth mojo back.
One issue is that Rackspace is transitioning its public cloud customers to OpenStack, an open source cloud operating system kicked off by Rackspace and NASA. Rackspace's public cloud revenue was up 41 percent from a year ago in the first quarter, but its overall revenue growth decelerated in a big way.
Instead of winning new accounts, Rackspace is concentrating on its existing base. In the end, it's possible that Rackspace winds up losing its early OpenStack momentum and ceding more ground to Amazon Web Services (AWS). TBR analyst Jillian Mirandi noted:
We believe the slowdown is due to Rackspace’s focus on migrating its existing customer base as opposed to winning new accounts, IaaS price cuts to better compete with lower-cost vendors AWS and Google, and growing competition.
Napier acknowledged that AWS is faring well, but expressed confidence that OpenStack would win developers and enterprises over time. Napier said:
It's clear that Amazon web services is doing really well. There lots of headlines about it there's lots of buzz about it. And so I think that is a clear data point for all of us to understand and think about...Our personal belief is that open source is a better development model framework than a proprietary system is. So that AWS absolutely has a head start and has a lot of developer traction. Personally I think over time there will be more developers contributing to the OpenStack than Amazon could hire.
Napier added that AWS is the proprietary cloud standard. In other words, welcome to Windows vs. open source cloud style.
The Rackspace CEO also countered the idea is losing share to AWS. AWS is just growing at a high rate.
Was the argument convincing? To a degree. The jury is still out on AWS vs. OpenStack, which has a ton of support. More worrisome for Rackspace may be the reality that it may have championed OpenStack, but may not be the big winner. Perhaps Red Hat runs away with the OpenStack cloud crown. Meanwhile, open systems don't necessarily translate to vendor success. Remember how open e-book formats were going to be a selling point against Amazon's Kindle?
The other worry for Rackspace is AWS' incessant price cutting. Rackspace's core pitch revolves around strong customer service. However, Rackspace has to be in the ballpark of AWS pricing. That game is probably unwinnable for Rackspace. Amazon is used to paper thin profit margins. In comparison to Amazon's retail business, AWS looks much better on the profit front. However, a good margin for AWS is likely to disrupt most enterprise IT vendors---including Rackspace.
Mirandi said that Rackspace has competition everywhere to worry about. On the high end, Rackspace will have service-led rivals like Verizon Terremark and Savvis to worry about. On the low-end, AWS has a lot of momentum. Rackspace could find itself in a tight squeeze.
Other analysts were mixed on Rackspace, but the general theme is the company is in a bind.
Colby Synesael, an analyst at Cowen & Co., said:
Cloud growth was impacted by recent price cuts and limited upsell opportunities with many customers still on its legacy platform whereas product expansion has been on its OpenStack platform. Weak managed hosting growth was simply the result of failed execution as it shifted too much focus to cloud last year. While management stated its primary goal is reaccelerating revenue growth we have a hard time seeing how this will occur anytime soon considering additional cloud price cuts are likely and the timing on the migration to OpenStack is still unknown.
JMP Securities analyst Patrick Walravens was more upbeat about Rackspace's prospects. Walravens outlines the following bullet points:
- The company's value proposition of superior support holds up over time.
- Rackspace's quarter was self-inflicted via a sales reorg that flopped.
- Enterprises will go for OpenStack pilots this year and that will benefit the company.
One quarter doesn't mean it's time to write Rackspace's obit, but there are long-term concerns to ponder. In the meantime, Rackspace needs to show some growth to let its OpenStack-powered master plan to play out.
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