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The big picture on Rackspace’s Q1: It’s becoming Mr. Hyde

Rackspace is the Dr. Jekyll of hosting. For the last few years, it has been a legacy managed hosting provider by day that dabbled in cloud computing at night. But as happened to Dr. Jekyll, Rackspace’s transformation has reached the point of no return.

In its past two quarters, Rackspace has derived more than 20 percent of its revenue from the “public cloud.” In its first-quarter results released on Monday afternoon, Rackspace reported cloud revenues of greater than 21 percent of its overall revenue (about $64.7 million of public cloud revenue out of just more than $301.3 million overall). Its cloud revenue was a 74 percent increase over last year, while “dedicated cloud” (read “managed hosting”) revenue grew just 22 percent.

Rackspace is becoming Mr. Hyde for good.

Whether that’s good or bad might depend on who you ask. Investors certainly weren’t happy with its missed profit mark in the first quarter, and shares tumbled in after-hours trading. But maybe they’re just thinking about the short term.

An optimist would note that Rackspace has been undergoing a lot of change lately, putting the finishing touches on its public-facing OpenStack-based cloud infrastructure. Assuming the OpenStack software — the result of an open source cloud computing project that Rackspace founded and still spearheads — really is superior to anything out there, and assuming the OpenStack ecosystem takes off as planned, Rackspace should have much brighter days ahead.

Truly, though, it’s tough to say. Even Amazon Web Services (s amzn), the undisputed king of cloud computing, has analysts scratching their heads. The business is booming, but signs that it’s operating on a cost-plus pricing model mean profits stay flat. But AWS is still a relatively small percentage of Amazon’s overall revenue. Amazon might be just fine collecting the millions more that cloud computing brings in each year so long as 10 percent of it remains pure profit.

Unless Rackspace is fine keeping profit margins where they are, though, it won’t be so lucky. The key to driving higher profits as a cloud provider appears to be adding value-added services above the infrastructure layer. Rackspace has always has “fanatical support,” so it might have to up its game into the fully managed cloud services like those AWS is offering with DynamoDB and Elastic MapReduce.

I have to think cloud computing is only an exciting new business model if it makes business better. As cloud becomes more and more of its being, we’ll see how Rackspace handles the change.

Image courtesy of Shutterstock user Netfali.

7 Responses to “The big picture on Rackspace’s Q1: It’s becoming Mr. Hyde”

  1. Interesting points, but I feel more and more big enterprises like Apple, Samy are either moving to the 99% and the rest becomes the 1% due to the fact that every startup can challenge biggies. Racksspace both def. targets this 1%, not 99%, who anyway build their own like MSFT, Apple, ORCL. Now, I strongly feel Cloud is not going to replace the DCs all over the world, due to the fact Amazon try to compete with everyone in the world and no one want to put their data out in public. Cloud is always going to be a backup or for scaling purpose or for time to market. Best example is Zynga, and the day Netflix comes out of AWS, it’ll seal the end of cloud tagged as a TEMP Server/Space for scaling. So, I don’t think Rackspace will have any issue in grabbing the majority share of 1%…!

  2. Michael Friedlander

    Whether it be traditional managed hosting or multi-tenant cloud platforms, Rackspace has definitely been a pioneer in providing “better than AWS” platforms coupled with support that most non-DIY end users desperately need. My observation of Rackspace is that they will continue to be successful in the SMB space competing directly with the likes of AWS, Azure, GoDaddy, etc. Where I believe they will continue to fall down is moving into the large enterprise arena where complex production environments require something other than the RAX “one configuration fits all” across their handful of Wintel/Linux images. Although a few large enterprises (Fortune/Global 2000) have accepted RAX’s presence, it will be extremely difficult for them to convert to a pervasive presence where they own most/all infrastructure services. Fundamentally, this is what dismays investors as RAX has made it clear that their growth would come through the larger end of “mid-size” and “large” enterprises whether it be due to technology, large enterprise experience, or compliance related issues.

    Conversely, as RAX continues to role out Openstack, I see no reason why they won’t continue to be successful with the developer/SMB community as well as grabbing rogue spend within discreet business units.

  3. Rackspace’s traditional hosting services are/were a cash cow. They were right to make the shift in focus to the cloud. They’ve been beating the drum for more than a couple of years now. I’m interested to see how their high touch business model translates to the public cloud which is lighter touch by definition.

    With Navisite, Terramark and similar hosting provider’s being brought up, I wonder how long Rack will be able to make a go as an independent company. They may have some protection with their current valuation but the next few quarters will be interesting.

    I’m a geek and not a financial analyst.

    • Derrick Harris

      You’re right that cloud is a different type of business. Rackspace has been primarily focused on straight cloud servers and storage the past few years, and while helping build OpenStack, so I think it will need to diversify its cloud business in order to really capitalize on the transformation.

      • Ditlev Bredahl

        OpenStack will not make a difference on it’s own here. Fact is that the IaaS market is commoditizing fast, and if anything – OpenStack will only accelerate that process…eventually make life harder for RAX – unless they are able to harness the ecosystem around it.

      • Ditlev makes an interesting point that was discussed on GigaOM earlier about if Rackspace is too late with Openstack. I don’t think this is an issue compared to where the overall market is at.

        I believe cloud consumers have made their minds up when it comes to AWS vs. VMWare vs. everything else. If they haven’t brought in to AWS or VMWare there’s plenty of work available Openstack.

        The question will be if it is a successful business vs. managed hosting.