Rackable Systems Oversold in Reaction to Dell-AMD Deal (AMD, DELL, RACK)

Another casualty of the announcement of the Dell (DELL) - AMD (AMD) relationship during Friday's trading was Rackable Systems (RACK). The server company has seen its stock drop 40% in a month, including 10% on Friday. The bears on the stock are suggesting that now that DELL has embraced AMD's Opteron on their high-end server offerings, that makes it much tougher for RACK to continue to gain market share. I think this is somewhat true, but given the magnitude of today's sell off, I have decided to initiate a small position anyway.

Here's how I see it. RACK is a nice little company in what I call the sweet spot of its growth stage. It has a billion dollar market cap and is growing its top line by about 100%.

Now it's obvious that they can not sustain that type of growth rate for long. Moreover, DELL and HPQ might very well get their act together and put it to the younger company. It's also true that servers are becoming more of a commodity which makes people nervous. But the way I view it, all tech hardware slowly becomes a commodity and controlling your cost and operating leverage helps tech companies offset declining prices. Besides, selling commodities is not always a bad thing -- just ask SBUX, PZZA, PD, etc...

The wildcard that lifts the tide for all the server company "boats" is the incredible increases in capex from the likes of Google (GOOG), Yahoo (YHOO) and even Microsoft (MSFT). All these companies are in an arms race to build server farms that are capable of hosting their customers, email, calendars, blogs, etc... Not to mention the MySpaces of the world.

The proliferation of PCs and the growth of the network has been almost completely saturated (at least domestically). Now everything needs to go online. And in order for that to be possible, you need servers and storage.

RACK 1-yr chart:

Full disclosure: long RACK.