Rackspace To Pay Price Of Doing The Right Thing

| About: Rackspace Hosting, (RAX)

Rackspace (NYSE:RAX) is making the right move by spinning off OpenStack into an independent foundation.

Rackspace built OpenStack from a NASA architecture and was heavily criticized within the open source community for dominating the open source cloud stack.

With over 100 companies now contributing to the stack, and the project's conference becoming a must-cover event, it made perfect sense for the company to announce the move on its blog, following up with a “governance town hall” aimed at building something similar to Eclipse, Apache or Mozilla.

But there's a price to be paid, in an open source world, for doing the right thing. It's hard to justify a PE of 84 when you don't control the environment you're running. The company is worth $4.62 billion while this year's revenue may barely top $1 billion. It must still invest heavily to accelerate top line growth, and it's bringing $1 in sales for every $10 down to the bottom line.

Now look up I-35 at Dell (NASDAQ:DELL). After some hesitation it has also committed to the cloud, using both OpenStack and a stack from Joyent that only went open source last month. Dell is investing $1 billion this year in its cloud efforts – that's Rackspace's entire revenue.

Investors currently bid Rackspace to a PE of 84. Dell sells at a PE of 8.

Yes, Dell has a lot of trouble in its hardware operations – it's married to Microsoft (NASDAQ:MSFT) and its coming Windows 7 tablet is another big risk. (Its Android-based Streak was also not a winner.) But Dell is making the right moves to take over a space Rackspace pioneered, and while Rackspace is doing the right thing by open source, it's going to have a hard time beating Dell's money.

Rackspace's PE is going to compress over time, and Dell's is going to expand. While Rackspace's growth rate may be more impressive, that rate may prove increasingly difficult to maintain, while Dell's cloud commitment should improve its results over time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.