Here's Why Profit Is Slipping At Rackspace Hosting

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 |  About: Rackspace Hosting, Inc. (RAX)
by: Leigh Drogen

Rackspace Hosting Inc. (NYSE:RAX) is set to report FQ1 2014 earnings after the market closes on Monday, May 12th. Rackspace is an American IT hosting company which provides hybrid cloud solutions to clients which allow workloads to be run on public cloud, private cloud, dedicated servers, or a combination of platforms. Over the past few weeks some of the biggest names in cloud services including Amazon.com (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) have been turning up with the heat on smaller players in the industry with price cuts. Since March 1st Rackspace stock has now fallen 27% from $36.07 to $26.28. Here’s what investors are expecting Rackspace to report Monday afternoon.

The information below is derived from data submitted to the Estimize.com platform by a set of Buy Side and Independent analyst contributors.

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(Click Here to see Estimates and Interactive Features for Rackspace)

The current Wall Street consensus expectation is for Rackspace to report 12c EPS and $419.83M revenue while the current Estimize.com consensus from 11 Buy Side and Independent contributing analysts is 12c EPS and $420.77M in revenue. This quarter the buy-side as represented by the Estimize.com community is expecting Rackspace to report in-line with Wall Street’s expectations on earnings while coming in marginally ahead of revenue projections.

By tapping into a wider range of contributors including hedge-fund analysts, asset managers, independent research shops, students, and non professional investors Estimize has created a data set that is more accurate than Wall Street up to 69.5% of the time.

More importantly it does a better job of representing the market’s actual expectations. It has been confirmed by Deutsche Bank Quant. Research and an independent academic study from Rice University that stock prices tend to react with a more strongly associated degree to the expectation benchmark from Estimize than from the Wall Street consensus.

The magnitude of the difference between the Wall Street and Estimize consensus numbers often identifies opportunities to take advantage of expectations that may not have been priced into the market. In this case we are seeing a smaller than usual differential between the expectations of Wall Street and Estimize.

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The distribution of estimates published by analysts on the Estimize.com platform range from 10c to 14c EPS and from $418.90M to $423.13M in revenues. This quarter we’re seeing a small to moderate range of estimates on Rackspace compared to previous quarters.

The size of the distribution of estimates relative to previous quarters often signals whether or not the market is confident that it has priced in the expected earnings already. A narrow distribution of estimates signals more agreement in the market, which could mean less volatility post earnings.

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Throughout the quarter the Wall Street EPS consensus fell from 14c to 12c while the Estimize consensus converged from the opposite direction by rising from 11c to 12c. Meanwhile Wall Street steadily took down its revenue consensus from $420.08M $419.83M while the Estimize consensus began the period at $420.87M and ended at $420.77M. Timeliness is correlated with accuracy and the directionality of analyst revisions are often a leading indicator. In this case we are seeing generally flat analyst revisions going into the report.

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The analyst with the highest estimate confidence rating this quarter is kbrower who projects 12c EPS and $423.13M in revenue. kbrower is ranked 86th this season among over 900 contributing analysts. This season kbrower has been more accurate than Wall Street in forecasting EPS and revenue 70% and 60% of the time respectively over the course of 10 estimates.

Estimate confidence ratings are calculated through algorithms developed by deep quantitative research which looks at correlations between analyst track records and tendencies as they relate to future accuracy. In this case kbrower is expecting Rackspace to report in-line with earnings expectations while beating the consensus from both Wall Street and the Estimize community on sales.

Competition has been getting fierce in cloud services lately. Unfortunately for many of the smaller players in the industry like Rackspace its difficult to compete with giants like Google and Microsoft which benefit from a much larger scale of operation. The Estimize community is expecting Rackspace’s earnings to drop 7c per share from 19c per share in FQ1 last year to 12c per share this quarter. Alongside the drop in EPS contributing analysts on the Estimize.com platform are expecting a 16% gain in year over year revenue. Rising revenue and shrinking profit margins at Rackspace are one example of the competition in cloud services is just beginning to heat up.