Rackspace's Head is In The Clouds

Rackspace Hosting, Inc. RAX reported third quarter earnings last night that were better than consensus, sending shares higher. The cloud computing company reported third quarter earnings of 14 cents per share on $265 million in revenues. Wall Street was looking for earnings of 14 cents per share on $261.63 million in revenues. In early Tuesday trading, shares of Rackspace were up 4% over Monday's close. The San Antonio, TX-based company said that total server count was up 6%, and total customers rose 6% as well. CFO Karl Pichler was very positive on the report. In the press release, Pichler said, "In summary, we are very pleased with this quarter's results. We are focused on finishing the year on a strong note and will give you a more in depth look into our 2012 plans when we report our full year results in February." In the company's release, CEO and President Lanham Napier said, “In the third quarter we improved upon the solid results that we delivered in the first and second quarters by continuing our strong pace of revenue growth while boosting margins and returns." Morgan Stanley was not as positive on the name as others, but that was mostly due to valuation. In a research note, the New York-based investment bank wrote, "Alongside increasing cloud demand, accelerated adoption rates for RAX's expanding portfolio of products, such as today's introduction of Rackspace Cloud: Private Edition, have contributed to the 32.5% Y/Y growth of revenues. By leveraging its existing expertise, RAX is able to sell more variations of the cloud product to existing customers and make itself more relevant to the growing interests of large Enterprise customers. Improved margins are a result of these new products as many of them have higher margins than the basic cloud product." Bank of America was much more positive, saying, "RAX remains our top infrastructure Cloud name which is differentiating itself through quality support, proprietary management software and scale.” Rackspace is in a very hot sector, cloud computing, and the company is growing like a weed. Revenues jumped 32.7% year over year, and earnings rose 60% year over year. It has been afforded a very high premium, trading at nearly 50 times expected 2012 estimates. As cloud computing continues to take off, some are expecting consolidation in this space. With a market cap of around $5 billion, Rackspace is one of the smaller cloud computing names, and is agile enough to get acquired by one of the larger IT companies in the coming months. Cloud computing is everywhere. Apple AAPL, Google GOOG, Amazon AMZN and a host of other major players are continuing to devote more resources toward cloud computing. As cloud computing continues to take shape and ultimately transforms the IT industry, this should benefit Rackspace, as the company's servers will continue to go up in number. With revenue growth of over 30% year over year and earnings growth of 60%, those are definitely some lofty metrics to keep your head in the clouds. ACTION ITEMS:

Bullish:
Traders who believe that Rackspace will continue to grow sharply over the coming years might want to consider the following trades:

• Go long Rackspace, despite the high valuation. If traders are concerned about this, perhaps wait until the $41 level, where there is technical support.

• Also consider names like Citrix Systems CTXS, VMware VMW and other major cloud computing names.

Bearish:
Traders who believe that Rackspace might see a slowdown in server growth may consider alternate positions:

• Rackspace is a momentum name, and any slight hit to the momentum could have traders leaving the name faster than you could imagine. Consider shorting aggressively.

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