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Rackspace spends big bucks to peddle its cloud vision

Striking while the fluffy hybrid iron is hot

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Rackspace Hosting may be growing its cloud business much faster than its overall business, but the company's rate of sales growth is declining and its profits are also getting pinched.

It is tough not to root for Rackspace, one of the founders of the OpenStack cloud controller project and a big hoster that is transforming itself into a public cloud. Rackspace is an underdog trying to take on industry juggernaut Amazon Web Services.

But facts are facts, and numbers don't lie.

Don't over-react. Rackspace is still growing and is still profitable. And as CEO Lanham Napier and CFO Karl Pichler pointed out in a call with Wall Street analysts going over the company's latest numbers, Rackspace is investing in its global data center build-out and doing branding and marketing, and is well aware that margins are lower than they were in 2011 and 2012.

Rackspace put a new cloud into Sydney, Australia during its most-recent quarter, is building new data center capacity in Virginia, and will be ramping up a data center in Hong Kong. Unlike hosting, the public cloud takes more initial capital investments because companies want to buy capacity on a cloud now.

"Our primary goal is to accelerate revenue growth," Napier explained, saying that now was the time to engage customers and sell its brand of hybrid private and public cloud computing and storage capacity. And when he was asked if Rackspace could get back to the 30 per cent or so growth rates it enjoyed across its entire business in 2011 and 2012, he said, "Man, we sure hope so. We are working hard to get there."

Napier stopped short of promising a 30 per cent growth rate, but said the company could grow faster than it did in the second quarter, and was doing the "heavy lifting" now to get in position to capitalize on future high growth in the cloud. He added that Rackspace was in the middle of its own transitions as it shifts from hosting to cloud, and as the industry makes a similar shift as IT consumers of both public and private clouds.

Still, falling profits even when you boost sales is what happens when you try to take on Jeff Bezos, e-retailing wizard, who is trying to do to computing and storage capacity what he did to books, music, and a slew of other consumer goods. Bezos knows how to make it very difficult for smaller scale operations to compete in whatever market he chooses. And Rackspace might be number two in the public cloud racket, but it is far behind Amazon Web Services.

In the second quarter ended in June, Rackspace grew its public cloud business by 36.4 per cent to $99m, which is pretty decent growth. But the dedicated cloud business – what you and I would no doubt call dedicated hosting – only saw a 12.4 per cent revenue bump to $276.8m. Total sales rose by 17.8 per cent to $375.8m, but net income fell by 11 per cent to $22.4m.

Research and development costs rose by 59.9 per cent to $26.8m, sales and marketing costs were up 26.5 per cent to $52.3m, and general costs rose by 24 per cent to $69.3m. These increased costs, representing an incremental $34.4m from the second quarter of 2012, are what ate into net income – and then some.

Dedicated hosting, er, cloud does not go away, by the way. Napier said that Rackspace was building the tools to have dedicated hosting become "part of the programmable cloud infrastructure," and that for a number of workloads, the performance of bare metal just blows away virtualized infrastructure and will be part of the mix in hybrid clouds that mix machines in the data center with dedicated and shared public cloud capacity.

Rackspace added 4,762 net-new servers in the quarter, and presumably a large portion of them were related to the build-out in Australia. This is one of the largest bumps in server capacity in a quarter for Rackspace. The company has increased its server pool by 13,906 servers in the past year.

Because all of that capacity has not yet been sold on the private cloud, average monthly revenue per server is down to $1,298. It was $1,308 per server per month in the first quarter and $1,310 per server per month in the final quarter of 2012. However, even with the dip, average revenue per server per month is up a smidgen (2.2 per cent, to be precise) year-on-year.

Rackspace blew $73m on customer gear for its dedicated hosting (er, cloud) business in the second quarter, which was higher than usual but still less than the $85.7m. Ditto for data center build-out expenses, which were $10.1m in Q2 but $13.2m in Q1.

Rackspace had 50.6 megawatts of data center capacity under lease as June came to a close, up 1.6 megawatts since a year ago, and 44.4 megawatts (up 35.8 per cent) of that were available for immediate use and 26 megawatts (up 14.5 per cent) were actually in use. The annualized net revenue per megawatt used stood at $59,305, which has been rising steadily each quarter – hopefully a lot faster than the electric bill.

The company had $263m in cash and equivalents in the bank as the June quarter closed and only $88m in debts (which includes capital lease obligations). While this is a tidy sum of money, it is nowhere close to the billions and billions that Google and Microsoft and Amazon can shell out to build up their clouds. Now you know why Rackspace started OpenStack and is trying to rally hosters, telcos, and others to build Rackspace-compatible clouds that can be federated and look like a giant virtual AWS or Azure or Compute Engine. ®

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