UBS Cuts Rackspace (RAX) EPS and PT on Transition Risk and Increasing Competition

Rackspace (NYSE: RAX) is (1) shifting to more enterprise deals, and (2) offering support for AWS and Azure clouds, according to UBS analyst Steven Milunovich. Booking larger deals is enticing though results can be lumpier and competition greater than in the company's core SMB market (see Nimble). The near term impact of moving to a more services heavy and capital light model is unclear.

Leveraging Fanatical Support makes sense. Ideally, RAX would be a pure services company but potential new customers might decide to use Rackspace's services and not its hosting. The company has said that it expects slower growth in its public cloud revenue going forward.

Amazon Web Services support revenue won't be material until F17 but should offer a similar margin and higher ROIC than the current mix. Early returns indicate that most AWS customers are choosing the more expensive Aviator support level.

Google, a small cloud player up to now, is ratcheting up its effort. We expect that Google could look to Rackspace for services support. The decision to be more cloud neutral may work out, but the transition is looking expensive as existing personnel are trained and new experts are brought on.

No change to Neutral rating but the PT drops to $28 on a combination of 5.8x 2016E EV/EBITDA (discount to comps for competition and business model transition) and 28x 2016E P/E (a premium for higher growth and potential from AWS support).

For an analyst ratings summary and ratings history on Rackspace click here. For more ratings news on Rackspace click here.

Shares of Rackspace closed at $25.48 yesterday.

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