Rackspace Investors Double Money on Open Source

Jul.20.11 | About: Rackspace Hosting, (RAX)

A year ago Rackspace (NYSE:RAX) was a sleepy little Web hosting company based in an abandoned San Antonio shopping mall.

So if you put $10,000 in its stock on that day, and $10,000 in Apple (NASDAQ:AAPL) stock, which investment would be doing better? It would be Rackspace by a country mile. The firm's shares have zoomed 162% in value over that time, while those of Apple are up “just” 51%.

The reason is an open source project called OpenStack, which the company announced at this time last year. OpenStack calls itself a “cloud operating system.” It enables private and public entities to transform server farms, using virtualization, into scaled systems that can take massive increases in traffic or do really big jobs on-demand.

The company's officials recently met 350 supporters from Europe, the Middle East and Africa in London. A spokesman called it a "voyage of discovery" because an open source project doesn't always know who is running their code.

Critics may call that a bug. Open source advocates call it a feature. Critics are right to note that, unless an OpenStack user is hosting on Rackspace, the company gains no direct financial benefit from the relationship. But all users can become part of an ecosystem, noted OpenStack project leader Jonathan Bryce, and these relationships can be leveraged:

  • Citrix' recent purchase of Cloud.com assures tight integration between its Project Olympus and OpenStack, which is now the project's foundation technology.

  • A commercial version of OpenStack for businesses, called Piston Cloud Computing, has drawn $4.5 million in venture funding.

  • Rackspace is now putting all its hosting services on OpenStack, providing economies of scale that will help it gain share in the hosting business.

  • Rackspace has launched a unit called Cloud Builders that is creating a distribution system for corporate clouds built on its services and support.

Cloud computing is rapidly transforming enterprise computing, becoming the “table stakes” to get into that huge game. It means that what took Facebook years to do can now be done in months. Enterprise computing has been “democratized.”

The first year of OpenStack was about building the ecosystem, and the coming year is about deployments, the company said. The company will roll out the fourth version of its system, dubbed Diablo, in September, and the money will really start rolling in.

Even at today's price of $43.74, with an astronomical P/E of nearly 120, Rackspace could still become a viable takeover target for Dell (NASDAQ:DELL) in nearby Austin, or for IBM (NYSE:IBM), which has extensive operations in Texas and open source credibility. A move by either of these companies, or by Hewlett-Packard (NYSE:HPQ), which badly needs a cloud play, could spark a bidding war for the company.

Or it could continue to grow on its own. That's the path most of its users would prefer, as an independent manager can avoid code forks that weaken the base. Either way, the little San Antonio company is winning right now, and few would bet against it.

Disclosure: I am long IBM.