RAX – A Waving Red Flag for Rackspace Stock

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Another day, another case of the double-edged sword of success.

In case you missed it, cloud computing stock Rackspace Hosting, Inc. (NYSE:RAX) reported first-quarter earnings after the bell yesterday. R

AX is a unique player in the hot cloud computing space, as it solely offers managed hosting — its differentiator against giants like Amazon.com, Inc. (NASDAQ:AMZN), Google Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and Microsoft Corporation (NASDAQ:MSFT).

So far this year, that differentiation (combined, of course, with the general cloud mega-trend) led to a string of earnings beats that sent shares of Rackspace stock steadily climbing higher. As you can see below, the stock had notched nice 14% gains since the start of 2015, blowing away the broader market.

But with a high stock price comes high expectations and — as you can see by that steep cliff at the right edge of the Rackspace stock chart — high risk.

Wall Street shockingly didn’t seem to care that RAX posted a seemingly solid quarter, and it certainly didn’t care about “recent highlights” like adding Tinder as a new customer. Instead, investors were unimpressed with the top line — both its recent performance and its future expectations — to the tune of a cringe-worthy 14% selloff.

rax stock

First things first, let’s take a look at the not-good-enough numbers that sent RAX stock back to earth. For one, the company reported a profit of $28.4 million, or 20 cents per share, which was right in line with analyst expectations. But trouble, once again, came on the top line. Revenue grew 14% to $480.2 million during the first quarter.

While that fell into the company’s expected range of $477 million to $484 million, it was just shy of the $481 million mark set by analysts. For the sour cherry on top, RAX also lowered its revenue expectations for the coming quarter to a range of $487 million and $492 million — significantly short of the analyst mark of $502 million.

One reason for the revenue dip was “a major customer’s unwillingness to send its data outside its own country … because of data sovereignty laws,” Bryan McGrath, the company’s vice president of finance, told The Wall Street Journal in an email message.

At first glance, an issue with one single customer may seem like little more than a blip — but the reality is that data sovereignty is an emerging hot-button issue that could continue to impact Rackspace and other cloud providers. Just consider what ComputerWeekly reported late last year:

“Large cloud providers such as IBM, Amazon, Microsoft, Google and VMware are building datacentres in Europe as enterprises based in the European Union (EU) migrating workloads to the cloud insist their data stays in the region.”

As seen with Rackspace, such in-country demands hold true elsewhere as well — making the only solution to actually build data centers in other countries where customers are based, as cloud providers have been doing in Europe. That’s all well and good, but it’s not cheap and will only make total costs (which already ticked up 14% year-over-year in the most recent quarter) keep rising.

That’s not to say RAX won’t bounce back, or that you might not want to snag some shares if you’re looking to invest in the cloud mega-trend. But don’t write off the busted customer deal — one that was big enough and bad enough to drive a revenue miss and lowered overall expectations — as a one-time thing.

As of this writing, Robert Martin did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/05/a-waving-red-flag-for-rackspace-stock-rax/.

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