There are two growth vectors for the cloud, software and services.
Both face competition, but both are relatively pure plays in their respective areas. Rackspace's main rivals, Google (NASDAQ:GOOG) and Amazon.com (NASDAQ:AMZN), do many other things. Same with Red Hat's main rivals, Microsoft (NASDAQ:MSFT) and VMWare (NYSE:VMW) – the latter is tied to data systems provider EMC (NYSE:EMC).
From the standpoint of investor returns, it's also important to look at these smaller players in contrast to mainline IT companies such as IBM (NYSE:IBM). It's the law of big numbers. Big numbers are harder to move higher than smaller numbers. At around $1 billion in sales, you're at a sweet spot, where numbers can move but where there's some stability, safety, and a reliable niche.
Seen from a one-year or a five-year perspective, investors have chosen the services route. RAX is up nearly 40% this year, RHT just under 11%. But go back six months and it's RHT that has the lead, rising 10.46% against RAX' 2.52%.
Enterprises have shifted their thinking in the last year. It's no longer to cloud or not to cloud, it's how to cloud.
Rackspace is a hosted cloud. You're giving up your data center, giving up control of corporate assets that are near-and-dear. You're trusting a service provider. Thus many CIOs are buying the idea of risk sold by enterprise players, “unpredictable downtime and security breaches,” like "the bad ol' days of corporate data centers."
But instead of taking that argument and blindly going with their current contracts, many now seem interested in building their own clouds instead. Advantage, Red Hat.
No one is pretending that Red Hat is scarfing up all the business here. Rackspace's Open Stack is a viable, open source cloud software option, just like Red Hat's OpenShift. VMWare and Microsoft will have their advocates in the corporate data suite.
But there is a basic problem with handing off corporate assets to a cloud provider like Rackspace. That is, moving the data. To get CIOs to a service strategy, providers will have to offer free data transit and direct peering. That's expensive, an additional layer of infrastructure cost that allows CIOs to make the decision of "if cloud, then let's make it our cloud."
Red Hat doesn't have to win the whole market in order to keep gaining in sales, price and valuation from its current base. The company has just passed a $1 billion run rate in revenues, its total valuation is $9.7 billion. It's right in the sweet spot for growth. The sales figures for Rackspace are close, it's also in this sweet spot, but note that its valuation is $5.74 billion, barely half that of Red Hat.
Smart investors are picking software over services, and private clouds over public ones.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.