Rackspace Seeks Turnaround Into Slowing Activity Ahead (NASDAQ:RXT)

A Quick Take On Rackspace Technology

Rackspace Technology (NASDAQ:RXT) went public in August 2020, raising $703.5 million in gross proceeds in an IPO that was priced at $21.00 per share.

The firm provides a range of IT cloud environment services for all major technology platforms.

With a heavy debt load, still-rising cost of capital and lower economic activity ahead, I’m on Hold for RXT in the near term.

Rackspace Overview

San Antonio, Texas-based Rackspace was founded to provide IT infrastructure solutions to enterprises.

After its take-private acquisition by private equity firm Apollo Capital Management in 2016, the firm has transitioned to a cloud-agnostic service focus on recurring revenue.

Management is headed by Chief Executive Officer Amar Maletira, who has been with the firm since 2020 and was previously Chief Financial Officer at Viavi Solutions and CFO at Hewlett-Packard Enterprise Services for Americas.

The firm provides multicloud services for the following infrastructure and software platforms:

• Amazon AWS

• Google Cloud

• Microsoft Azure

• VMware

• Oracle

• Salesforce

• SAP

• Others

The company pursues new customers via a dedicated sales and marketing force optimized by specialty and business unit functions.

Rackspace reports operating activity via three segments:

• Multicloud Services

• Apps and Cross Platform

• OpenStack Public Cloud

RXT has more than 6,800 employees, 2,500 of whom are cloud-certified professionals and 900 are quota-bearing representatives.

In addition, the firm has developed an ecosystem of more than 3,000 partners.

Rackspace’s Market & Competition

According to a 2020 market research report by Grand View Research, the global market for cloud computing was valued at $266 billion in 2019 and is expected to reach $808 billion by 2027.

This represents a forecast CAGR of 14.9% from 2020 to 2027.

The main drivers for this expected growth are the historic and multi-decade transition by enterprises from on-premise systems to cloud infrastructures.

Also, the chart below shows the historic and forecast U.S. cloud computing market size, by use, from 2016 to 2027:

Major competitive or other industry participants include:

• Accenture

• Atos

• Capgemini

• Cognizant

• Deloitte

• DXC Technology

• IBM

• Equinix

• QTS

Rackspace’s Recent Financial Performance

• Total revenue by quarter has risen per the following chart:

• Gross profit margin by quarter has trended lower, as shown below:

• Selling, G&A expenses as a percentage of total revenue by quarter have also trended lower in recent quarters:

• Operating income by quarter dropped sharply into negative territory with the impairment of goodwill and assets:

• Earnings per share (Diluted) have also remained negative since the company went public:

(All data in the above charts is GAAP)

In the past 12 months, RXT’s stock price has dropped 80.6% vs. the U.S. S&P 500 index’s drop of around 16.9%, as the chart below indicates:

Valuation And Other Metrics For Rackspace

Below is a table of relevant capitalization and valuation figures for the company:

Measure [TTM]	Amount
Enterprise Value / Sales	1.3
Enterprise Value / EBITDA	32.3
Revenue Growth Rate	5.6%
Net Income Margin	-21.6%
GAAP EBITDA %	4.1%
Market Capitalization	$563,663,744
Enterprise Value	$4,122,836,000
Operating Cash Flow	$343,300,000
Earnings Per Share (Fully Diluted)	-$3.19

Click to enlarge

(Source – Financial Modeling Prep)

Commentary On Rackspace

In its last earnings call (Source – Seeking Alpha), covering Q3 2022’s results, management highlighted that it expects 2023 to ‘be a transition year with a lot of heavy lifting,’ presumably with continued expense reductions.

To rebuild, the company will focus on public cloud value-added services as well as reigniting its managed hosting and private cloud businesses.

The recent hack in its Hosted Exchange email service only highlights the need for the firm to improve its execution in the highly competitive cloud services environment.

As to its financial results, total revenue rose only 3% year-over-year after Forex headwinds in its European geography due to the strong US dollar.

This Forex headwind is starting to abate as the dollar loses some of its strength.

Management didn’t disclose any company retention rates, which leaves investors blind as to how well it is retaining customers and cross-selling to those customers.

The firm continues to generate material losses and gross margins have been trending lower in recent quarters.

For the balance sheet, RXT ended the quarter with $285.7 million in cash, equivalents and trading asset securities and $3.46 billion in total debt.

Over the trailing twelve months, free cash flow was $192.2 million, of which capital expenditures accounted for $86.6 million. The company paid $78.2 million in stock-based compensation.

Looking ahead, management guided Q4 revenue to $777 million at the midpoint of the range and non-GAAP earnings per share of $0.05.

Regarding valuation, the market is valuing RXT at an EV/Sales multiple of only 1.3x.

Notably, RXT’s EV/Sales multiple [TTM] has compressed by 37.7% in the past twelve months, as the Seeking Alpha chart shows here:

The primary risk to the company’s outlook is whether management will be able to regain the company’s competitiveness and reignite revenue growth while making progress toward operating breakeven during a soft economic period ahead.

Soft economic periods usually result in lower CapEx spending from customers, slower sales cycles and greater conservatism by prospective customers.

With a heavy debt load, still-rising cost of capital and lower economic activity ahead, I’m on Hold for RXT in the near term.