The University of Texas at Dallas
Naveen Jindal School of Management
Rackspace Hosting Investment Report
Industry:
Information Technology Services
Recommendation: Buy
Rackspace Hosting, Inc. (NYSE: Rackspace)
Date: 1/25/2013
Sector: Technology
Industry: IT Services / Consulting
Recommendation: Buy
36% average revenue growth, 2x the industry 18% average revenue growth
Rackspace earned $1.03B revenue in 2011, 2.8x its revenue in FY07. The company had an
average 36% y/y growth rate during FY07 - FY11, 100% higher than the industry average 18%.
It is estimated to maintain the strong growth with a 28% CAGR through 2016.
Founded: 1998 / IPO: 2008
Headquarter: San Antonio, TX
Data Centers: Grapevine, Richardson, Chicago,
Herndon, Ashburn, London, Slough, Hong Kong
Scales: 4,596 Rackers; 197,635 Customers;
89,051 Servers
Target Price (12/31/13):
$ 90.07 (+14.11%)
Current Price:
$ 78.93
120% higher than industry EBITDA margin
Rackspace has an estimated EBITDA margin 33% in FY12. The company is estimated to
increase its EBITDA margin to 35.8% by 2016, 2.2x higher than industry average EBITDA
margin.
46% CAGR on number of customers
The sustainable business model and outstanding “Fanatical Support” help Rackspace
continue attracting new customers. By 3Q12, the company provided service to almost 200,000
customers, which was a 6x increase from 2007.
Solid financial metrics
Market Cap:
$ 10.81B
Shares Outstanding:
136.95M
Our analysis of Rackspace shows very solid financial metrics. It outperforms the industry
average in profitability, operating efficiency, liquidity, and solvency. In the past five years, ROE
increased from 11.8% to 15.1%.
Float:
111.59M
Bullish stock performance
Institutional Ownership:
79%
Revenue ($mm)
On 1/25/13, Rackspace’s stock price reached $78.93, an 84% increase from its 52-week-ago
price. Esimated target price is $90.07, a 14% increase from current price. We rate Rackspace
common shares as a buy recommendation.
$3,500
$2,800
$2,100
$1,400
$700
$0
07A
08A
09A
10A
11A
12E
13E
14E
15E
16E
Net Income ($mm)
$420
$350
$280
Valuation Ratios
$210
Price/Earnings (TTM)
Price/Earnings (Forward)
$140
PEG (5 year expected)
$70
EV/EBITDA (TTM)
$0
07A
08A
09A
10A
11A
12E
13E
14E
15E
16E
Earnings per Share
$3.00
$2.50
Per Share Data
109.63
89.05
Earnings (TTM)
Sales (TTM)
0.72
0.95
3.01
Book Value (MRQ)
5.71
28.73
Cash Flow (TTM)
2.90
Profitability Ratios (%)
Management Effectiveness (%)
Gross Margin (TTM)
Operating Margin (TTM)
71.37%
13.14%
Return on Equity (TTM)
Return on Assets (TTM)
15.09%
9.20%
Net Profit Margin (MRQ)
8.11%
Return on Capital (MRQ)
12.5%
Financial Strength
$2.00
Dividend Information
$1.00
Quick Ratio (MRQ)
Current Ratio (MRQ)
$0.50
LT Debt/Equity (MRQ)
10.0%
$0.00
Total Debt/Equity (MRQ)
19.2%
$1.50
07A
08A
09A
10A
11A
12E
13E
14E
15E
1.3
1.5
Dividend Yield
Dividend per Share (MRQ)
-
Payout Ratio (MRQ)
-
16E
1
Rackspace Hosting, Inc. (NYSE: Rackspace)
Business Description & Business Model
Figure 1: SWOT Analysis (Appendix 1)
Rackspace is one of the leading companies providing managed hosting services. It is also an
early cloud-computing adopter in the rapidly growing public cloud infrastructure-as-a-service
(IaaS) market. It offers a portfolio of services, including dedicated cloud hosting1, public cloud
hosting, private cloud hosting, and hybrid hosting. Rackspace differentiates itself through high
quality support known as “Fanatical Support” (See Competitive Positioning), proprietary
software, and infrastructure scale. The company mainly serves small and medium-sized
businesses (SMBs) and is developing more Fortune 100 enterprise customers. It is also the
initial sponsor of OpenStack, an open-source cloud management platform. Rackspace
operates eight data centers worldwide and has customers in over 120 countries.
Source: Team estimates
Table 1: Rackspace Business Model
Rackspace Business Model
Broad Group of Customers
No customer >2% of sales
Customers in more than 120 countries
Fanatical Support Differentiation
Subscription based, recurring revenue model
Consecutive growth since inception
Growth nearly all organic
"Loyalty Model" Drives Profitability and Returns
Unit based economics
Lean services delivery model
Source: Company reports
Table 2: Rackspace mainly operates in the Complex Managed
segment ($ mm)
US Hosting Infrastructure
Svcs
2011
2012
2013
2014
2015
2016
11 - 16
CAGR
Shared & VPS
1,806
1,855
1,923
1,995
2,066
2,129
3.3%
561
582
603
625
647
669
3.6%
Complex Managed
6,914
7,468
8,057
8,678
9,309
9,944
7.5%
Co-location
2,057
2,223
2,404
2,598
2,798
3,004
7.9%
Dedicated
Total US
11,338
12,128
12,987
13,897
14,820
15,746
6.8%
Global Hosting Infras
Svcs
2011
2012
2013
2014
2015
2016
11 - 16
CAGR
Shared & VPS
4,938
5,093
5,331
5,570
5,785
5,990
3.9%
Dedicated
1,534
1,598
1,672
1,745
1,812
1,882
4.2%
18,904
20,505
22,334
24,229
26,068
27,977
8.2%
Co-location
5,624
6,104
6,664
7,254
7,835
8,451
8.5%
Total global
31,000
33,300
36,000
38,800
41,500
44,300
7.4%
Complex Managed
Source: IDC and team estimates
Figure 2: 2011 U.S. Managed Hosting Market
Rackspace offers companies a solution to shift IT investment from premise-based to cloudbased. It has a subscription-based business model that contributes approximately 98% of the
total revenue on a recurring basis. At its core, Rackspace is a service company delivering
premium-quality “Fanatical Support” (Table 1). The company follows Economic Value Added
(EVA) pricing discipline to ensure that growth and capital investments create stockholder value.
Industry Overview
Managed Hosting
Managed hosting provides IT solutions for dedicated companies
Managed hosting, which is also known as the “dedicated cloud” as defined by Rackspace,
refers to services that offer a single server or services for a specific customer. The customer
has full administrative privileges and is responsible for all functions. Managed hosting services
free customers from owning and managing in-house data centers. Target customers in this
segment are mainly large corporations.
The managed hosting market has an estimated 7.5% CAGR in the U.S. and 8.2%
globally through 2016
Segments of the “hosting infrastructure service” market are shown in Table 2. Rackspace falls
into the complex managed hosting segment, which totaled $7.47B in 2012 and is expected to
reach $9.94B in 2016, resulting in a 7.5% CAGR. We estimate that the global complex
managed hosting market will have an 8.2% CAGR through 2016.
The fragmented market will experience consolidation. The top three players are
projected to seize close to 45% of total market
The U.S. hosting infrastructure service market is very fragmented (Figure 2). In 2011, the top
three players (IBM, AT&T, and Rackspace) inside the hosting infrastructure market account for
nearly 27% of the U.S. market. Companies who can maintain their advantages and hone their
merger-integration skills will be able to survive and expand their market share. After a rapid
consolidation stage, companies will focus more on expanding their core business and continue
to outperform competitors. Based on the Harvard Business School consolidation life cycle
model (Appendix 2), we estimate that the top three companies inside the market will be able to
represent nearly 45% of the total market share as the industry matures.
Public Cloud
The Public cloud provides pooled IT resources on demand
The public cloud offers on-demand computing, storage, and network resources in a shared
multi-tenant environment. The public cloud delivers cost saving and efficient IT solutions that
utilize the pay-per-use models and help customers turn long-term capital expenditures into
short-term recurring operating expenses. The public cloud is also able to reallocate computing
resources promptly based on customers’ IT needs.
Source: IDC and team estimates
IaaS is the fastest growing cloud sector with 34% CAGR and expected to be a 20.1$B
market in 2016
The IaaS market is critical as it provides fundamental support to all other cloud segments. In
this market, Rackspace operates in cloud computing and storage services.
1
Dedicated Cloud, Managed Cloud, Dedicated Hosting, and Managed Hosting are same concepts.
2
Rackspace Hosting, Inc. (NYSE: Rackspace)
Figure 3: Managed Hosting Landscape from 2010 to 2012
Table 3: Public Cloud IaaS Market Growth ($ bn)
2011
Cloud Compute Services
y/y growth
Storage as a Service
y/y growth
Total Cloud IaaS
y/y growth
3.4
2012
4.9
2013
7.3
2014
10.8
2015
15.3
2016
54.5% 44.1% 49.0% 47.9% 41.7% 31.4%
0.9
1.1
1.7
2.4
3.3
4.2 36.1%
38.5% 22.2% 54.5% 41.2% 37.5% 27.3%
4.3
6.0
9.0
13.2
18.6
24.3 41.4%
51.2% 40.1% 50.0% 46.7% 40.9% 30.7%
IDC estimated Cloud IaaS
5.7
y/y growth
na 32.7% 29.7% 27.3% 26.5% 27.3%
Team estimated Cloud IaaS
y/y growth
CAGR
20.1 42.7%
4.7
7.6
6.4
9.9
8.8
12.6
11.8
15.9
15.8
20.2 28.7%
20.1 33.6%
51.2% 35.9% 36.6% 34.8% 33.4% 27.7%
Source: Gartner, IDC, and team estimates
Competitive Positioning
Source: Gartner
Competitive Advantage
Table 4: Rackspace and Competitors
Type
Major Players
Do-it-yourself solutions with
AT&T, Equinix, CenturyLink
a colocation partner
IT outsourcing providers
CSC, HP, and IBM
Pure-play Hosting providers AT&T,CenturyLink, Softlayer, GoGrid, Savvis
Large technology companies Amazon, Microsoft, Google, IBM
Source: Gartner and team estimates
Figure 4: Service Comparison
Service Features Rackspace Amazon EC2 Savvis
IBM
GoGrid
Free Support
100% Guarantee
As shown in the figure 3, Rackspace has been a leader in the managed hosting market since
2008 and has increased its competitiveness over the years. We categorize Rackspace
competitors in four types (Table 4). Appendix 3 shows detailed comparision with other
competitors. There are five reasons that differentiate Rackspace in the competitive landscape:
Rackspace differentiates itself by the “Fanatical Support” service
Rackspace enables clients to make strategic IT transitions without having to manage remote
data centers or maintain its own IT staff. Rackspace is also one of the few companies that
offer Service Level Agreements (SLAs) that would refund up to 100% of the customer’s bill if it
did not maintain its 100% uptime guarantee. This business model helps Rackspace achieve
long-term revenue generation (56 months stay per client) and low churn rate (0.9%). Figure 4
shows the detailed customer support features compared with other competitors.
Specialist vs. Generalist
No service provider in the market does everything well. Pure-play hosting providers are
specialized in one area that it does extraordinarily well. Large players (Co-location & Network
providers) offer a wdide range of services, but may miss certain specific crtieria that customers
need. Rackspace’s laser-like focus positions itself as a mission-critical extension of its
customers' IT department, differentiating itself from major technology companies (Amazon,
Google, and Microsoft).
Phone
Real Person Support
Live Chat
Urgent Response
24 / 7
Online Resources
Forums
Source: Team estimates
The economies of scale
Rackspace has reached an industry benchmark of $1B run rate due to its large installed
customer base and growth profile. This run rate contributes long-term cost advantages to the
company, as evidenced by the increasing EBIT margin (Figure 5). The majority of the costs
are upfront such as the labor to provide service and the fixed cost to install servers. There are
few managed hosting and cloud IaaS companies who have achieved the same run rate (EMC,
VMware, Cisco Systems, Oracle, and Intel).
Figure 5: Rackspace EBIT Margin
15%
10%
5%
0%
2007A
Gartner estimates that the
total worldwide public
cloud market will reach
$206.6B in 2016 from
$91.4B
in
2011,
representing 18% CAGR.
Among all public cloud
services,
the
IaaS
segment will experience
the fastest 33.6% CAGR
through 2016 (Table 3).
2008A
2009A
2010A
2011A
EBIT Margin
Source: Company reports
Table 5: Rackspace vs. Amazon
Rackspace
Performance Steady & predictable
performance
Service
Delicated & Superior
support
Platform
Open source
Amazon
Unstable performance
Price
Lower on average, can be
expensive depends on
services involved
Lower for SMB, higher
on average
Do-It-Yourself solution
Closed source
Source: Cloud Spectator and team estimates
Commitment to open technology standard
Most of the managed hosting companies have utilized the cloud technology to enhance their
services, offer more product varieties, and increase competitiveness. The open proprietary
technologies enables clients flexibility in deployment / features, larger agility to scale up and
down, standards for broad deployment, and no fear of lock-in. See detailed feature
comparision in Appendix 4.
Effective cost control
During our visit to Rackspace, we were impressed by its meticulous cost control efforts. The
headquarter was renovated from a mall and was purchased at a low price. As we entered the
building, we felt a great sense of professional ambiance. The company uses low cost furniture
and tools from local suppliers. In addition, it keeps operating expenses low by leasing data
center space and locating outside major city centers.
Rackspace vs. Amazon
Rackspace is ranked #2 by market share in the public cloud industry next to Amazon. We
compare Rackspace and Amazon in performance, service, platform, and price (Table 5). They
3
Rackspace Hosting, Inc. (NYSE: Rackspace)
are differentiated by major services provided and utilized platforms. Amazon offers a big list of
do-it-yourself (DIY) products at low prices, whereby Rackspace provides more direct,
customizable, and personalized solutions. Rackspace also offers more stable and predictable
performance, as shown in Appendix 5, and charges a lower price and offers more choices for
SMBs, as shown in Appendix 6.
Table 6: Rackspace’s Main Customers
Criteria
Support & Reliability
Culture of customer service
Focus on world-class customer outcome
Customers
Aon, Aramark
Boston Celtics
Full Hybrid Hosting Suite of Solutions
GlamMedia, Github
Portfolio approach = best fit for customers
FreshBooks
Technology form factor for every IT workload
Product capability & Best Technical Features FIFA, Vodafone
Repeatable and productized solutions
Carlsberg
Speed to market
Richards Group
Open source & standards-based
Core|K12
Source: Company reports
Rackspace should sustain a larger market share in SMBs because it offers select-a-size,
customizable IaaS backed by comprehensive "Fanatical Support". It provides SMBs a lower
cost of ownership of technology, which is essential for SMBs who typically have a smaller
revenue base and limited IT talent available. In 2011, Rackspace has won the Best SMB
Product award at the 2011 Cloud Computing World Series Awards for its managed cloud
solution. Also, Rackspace has taken demonstrable steps to develop an enterprise-centric
service. It enhances solutions for enterprises by introducing high-quality service, such as
Intensive Support (Awarded “Product of the Year” by Frost & Sullivan). Rackspace has also
increased its number of Fortune 100 clients from 32 to 60 in the past two years. With scaled
capability and excellent service, Rackspace will be able to attract more enterprises that need
customized service for their IT transformation.
Financial Analysis
Revenue and CAPEX
Figure 6: Rackspace Revenue and EBITDA Margin
$4,000
55%
$3,000
45%
$2,000
35%
$1,000
25%
$0
15%
08A
09A
10A
11A
12E
Total Revenue, Net
13E
14E
Revenue Growth
15E
16E
EBITDA Margin
Source: Company reports and team estimates
Table 7: DuPont Factorization Analysis on Rackspace
Year
2007 2008 2009 2010 2011
Profit Margin
Asset Turnover
4.08% 4.80% 5.94% 7.45% 8.11%
1.08x 0.93x 1.09x 1.15x 1.12x
Financial Leverage 2.54x 1.91x 1.74x 1.71x 1.59x
Source: Capital IQ
Figure 7: Rackspace 2012 Margins vs. Web Hosting Industry
80%
60%
40%
20%
0%
Gross
SG&A
EBITDA
EBITA
EBIT Normalized
Margin % Margin % Margin % Margin % Margin % Net Income
Margin %
RAX
Indystry
Source: Capital IQ and team estimates
Rackspace’s revenue has grown 30% on average during FY07 – FY12. The IPO in FY08 led
to a spike of revenue growth (Figure 6); the issuance provided Rackspace sufficient capital to
acquire potential competitors and expand its business. The revenue growth during FY09 –
FY11 was primarily driven by the increased services provided, which contained two
components: increased number of new customers (almost doubled) and incremental services
rendered to existing customers. We estimate the y/y growth in 4Q12 will be 26.7%, leading to
28.3% annual growth for FY12.
During FY09 – FY11, Rackspace spent nearly 34% of CAPEX each year on new data center
leasing and office build-outs. In addition, the company spent 67% on customer gear.
Rackspace insists that there is a relation between customer-gear capital expenditure and
incremental revenues: every $1 spent on growth CAPEX generates $2 additional revenue
(Appendix 9). This revenue / CAPEX ratio has improved between FY09 – FY11 from 1.74 to
2.07 suggesting that Rackspace is operating more efficiently.
Profitability and Margins
Rackspace has increased its ROA from 5.1% to 9.2% and ROE from 11.8% to 15.1% during
FY07 – FY12. DuPont factorization (Table 7) indicates that the surge is primarily driven by a
doubling of the company’s profit margin (4.08% – 8.11%) and a drop in its financial leverage
(2.54x – 1.59x), while the asset turnover was little changed (1.08x – 1.12x).
Rackspace’s margins are generally higher than the industry average (Figure 7). Its EBITDA
margin increased steadily from 24.1% to 31.1% during FY07 – FY12 because of its recurring
revenue model and just-in-time approach. The decreases of COGS / revenue and SG&A /
revenue are the leading factors for Rackspace’s higher EBITDA margin. During FY07 – FY11
cost of revenue as a percentage of revenue dropped from 32.7% to 30.2%; SG&A as a
percentage of revenue dropped from 43.3% to 38.7%. The two ratios are expected to continue
decreasing as the public cloud offers excess capacity utilization in a less humanized manner.
Another driver of EBITDA margin is the service level. The higher the service level Rackspace
provides, the more value it creates.
Cash Flows
Rackspace’s operating cash flow grew from $105M to $343M during FY07 – FY12. The
operating cash flow as a percentage of revenue increased from 19% to 41%. The main uses of
cash for Rackspace are capital expenditures and a few acquisitions. In FY10, the company
spent $30M acquiring Cloudkick. It spent $117M, $145M, and $270M on capital expenditures
in FY09, FY10, FY11, respectively. We estimate the capital expenditure will continue to grow
in the future for expansion.
4
Rackspace Hosting, Inc. (NYSE: Rackspace)
Figure 8: RAX 5-year Solvency
40
1.5
20
0.8
0
0.0
2008
2009
2010
2011
LTM
Interest Coverage Ratio (Left Axis)
Debt / Equity (Right Axis)
In FY09 and FY10, Rackspace generated negative cash flows because it used cash to
develop business and pay down its debt. We estimate Rackspace will continue generating
positive total cash flows due to an anticipated significant increase in net income and minimal
debt related payments.
Balance Sheet and Financing
Source: Capital IQ and team estimates
Because Rackspace used a major portion of its cash to pay off its debt, its liquidity ratio
experienced a downtrend during FY08 – FY10. However, as the debt decreased, both the
current and quick ratio increased above 1.0, indicating greater operating liquidity. This also
improved the firm’s long-term solvency, which is reflected by the fact that both the debt-toequity and interest coverage ratios are above historical levels (Figure 8).
Figure 9: Rackspace’s Z score
24.859
19.314
17.365
8.052
5.948
Other uses of cash are payment for capital lease and debt. Rackspace recognizes its
datacenter lease as a capital lease. The payment for capital leases increased from $13.9M to
$65.8M during FY07 – FY11. The company repaid most of its debt during FY07 – FY10,
resulting in $0.9M debt in FY11 from $211M in FY08.
Rackspace’s Z score was 19.3 in 3Q12 (Figure 9), indicating a low risk of bankruptcy (above
the 2.6 threshold for a financially sound company). The Z score has increased from 5.95 to
24.86 during FY08 – FY11, suggesting continuous improvement of its financial status.
Investment Summary
2008
2009
2010
2011
LTM 3Q12
Source: Capital IQ and team estimates
Figure 10: Operating Cycle of Managed and Cloud Hosting
In the public cloud market, Rackspace will benefit from organic growth of existing customers,
total market expansion, and share gains from other existing players. The public cloud IaaS
business has an estimated 33.6% CAGR. We believe the IaaS is in the early stage of its
business cycle and will expand significantly in the next four years (Figure 10). Throughout the
forecasting period, Rackspace is expected to have significant upside potential by attaining an
estimated 8.4% of the global IaaS market share.
Source: CFA institute and team estimates
Due to the fast expanding public cloud market, Rackspace should overshadow competitors in
public cloud by FY16 according to our forecasting model. From enterprise IT spending, we
observed a trend to move from traditional solutions, such as In-house IT and outsourcing, to
emerging cloud solutions. Moving to cloud business can effectively increase Rackspace’s perserver efficiency and future ROC gains. We estimate Rackspace’s public cloud segment
represented 23% of its total revenue in FY12 and can increase to 49% in FY16 (Figure 11).
Figure 11: Rackspace Revenue Distributions
100%
80%
60%
40%
20%
0%
2007A 2008A 2009A 2010A 2011A 2012P 2013P 2014P 2015P 2016P
Managed hosting
Public cloud
Source: Company reports and team estimates
Figure 12: Rackspace EBITDA and EBITDA Margin
$1,250
37%
$1,000
34%
$750
31%
$500
28%
$250
25%
$0
07A
08A
09A
EBITDA
10A
11A
12E
13E
14E
15E
16E
EBITDA Margin % (Right Axis)
Source: Company reports and team estimates
Rackspace is gaining share in maturing managed hosting and leading in high-growth
public cloud
In the managed hosting market, Rackspace will benefit from market consolidation, total market
growth and share gains from other smaller hosting companies, larger outsourcers, and inhouse IT departments. The managed hosting market has an estimated 7.5% CAGR.
Throughout the forecasting period, Rackspace will represent 11.4% of the U.S. market share
and 4.0% global market share.
22%
“Fanatical Support” leads to sustainable business model
Talented employees represent one of the most valuable assets. Rackspace will likely continue
recruiting and retaining cloud experts to assure its “Fanatical Support” services. The
comprehensive service should be able to secure Rackspace an enviable position within the
future private cloud market. Rackspace has a variety of customers spreading over 120
countries. No single customer accounts for more than 2% of its revenue, securing its stable
revenues in the future.
EBITDA margin is expected to improve as market consolidates
Rackspace has maintained steadily growing EBITDA margins over the last five years - 31.1%
in the end of FY11 - as it keeps investing in the public cloud segment (Figure 12). Rackspace
projects its longer-term target of adjusted EBITDA margin at 47% or more as the market
matures, suggesting there is still significant upside potential. Rackspace has arranged lease
agreements on data centers, thus its payments will match revenue more proportionally. We
believe that Rackspace will be able to generate solid EBITDA margins of 32% – 35% over the
next five years.
5
Rackspace Hosting, Inc. (NYSE: Rackspace)
Solid financial metrics support Rackspace stock appreciation
Rackspace delivers solid financials by displaying enviable revenue growth, efficient CAPEX,
and service-improved margins. It also outperforms industry average in profitability, operating
management, liquidity, and solvency. The five-year ratio analysis indicates a favorable trend
for a continuation of Rackspace’s financial status. Over the past five years, Rackspace’s
revenue has grown at an average rate of 28%. The high growth rate should continue due to
business expansion and improvement of efficiency. In the past three years, ROE increased
from 11.8% to 15.1% due principally to an increase in profit margin.
Figure 13: Rackspace Cloud Products Portfolio
Source: Company reports
Table 8: Rackspace Target Price
Methods
Weight Target Price ($)
Multiple
70%
90.87
Precedent Transaction 10%
91.18
Discounted Cash Flow
20%
86.70
Total
100%
90.07
Source: Team estimates
OpenStack should help Rackspace expand addressable market
Rackspace was one of the major contributors to OpenStack, an open source cloud platform
enabling companies to build, deploy, and manage cloud computing in all forms. This platform
can potentially expand its addressable market by allowing Rackspace to extend services to
future OpenStack users and handle much larger deployments. However, since OpenStack is a
best-effort platform with incomplete features and Rackspace is no longer its major contributor,
additional time and data are needed to ensure its potential.
Valuation
Three methods were used to derive a weighted one-year target price $90.07 (Table 8).
Trailing Multiple Method
Figure 14: Rackspace TEV/EBITDA Multiple Trend
Rackspace’s eight-quarter trend suggests 21.5x trailing TEV/EBITDA for FY13
25
Rackspace’s trailing TTM TEV/EBITDA multiple has remained stable for the past eight
quarters, ranging from 17x to 24x. Based on its previous trend (Figure 14), we forecast 21.5x
as TTM TEV/EBITDA for 4Q13. In our projected financial statements for FY13, the estimated
total debt (including capital leases), cash, and shares outstanding as of 12/31/13 are $162.4M,
$235.7M, and 136.9M respectively. Therefore, the implied one-year target price is $90.87
(Table 9).
20
15
10
5
0
4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12
…
4Q13E
Source: Capital IQ and team estimate
Table 9: Rackspace TEV/EBITDA Trend Valuation
(MM)
FY13 E
Implied TEV Implied Eqt Value Implied Share Price
EBITDA
$575.18
$12,366.41
$12,439.74
$90.87
Source: Capital IQ and team estimates
One-year target price is supported by multiples of comparable companies
Table 10: Comparable Multiples, as of 1/25/13
TEV/
Company Name
Akamai Technologies, Inc.
Equinix, Inc.
Citrix Systems, Inc.
Red Hat, Inc.
Median
Mean
Rackspace Hosting, Inc.
Share Price/
Sales EBITDA Diluted BV of
TTM TTM
EPS Tangibles
5.2
7.3
5.1
7.8
6.3
6.4
8.6
12.9
17.2
21.7
37.7
19.5
22.4
28.7
Source: Capital IQ and company reports
38.0
92.4
39.1
75.7
57.4
61.3
109.7
5.0
11.0
14.0
14.6
12.5
11.2
15.7
We selected four companies with similar size and business to Rackspace (Appendix 16). We
used the TEV multiples instead of equity multiples, because the capital structures of
Rackspace and its peers are substantially different (Table 10). After comparing Rackspace
with these companies, we estimate that Rackspace’s TTM TEV/EBITDA for FY13 ranges from
19x to 22x, leading to a implied price range $80.36 – $92.97 (Table 11). Since Rackspace has
a higher-than-average TTM operating profit growth, the second largest three-year CAGR, and
increasing market share, a high price within the range should be reasonable, offering support
for the target price derived from the eight-quarter trend.
Table 11: Valuation based on TEV multiples
Multiple Range FY13E
Implied TEV Range
Multiples
Low - High EBITDA
Low High
TEV/EBITDA 19.0x
22.0x 575.2
10,928.5
12,654.0
Implied Equity Value
Low
- High
11,001.8
12,727.3
Implied Share Price
Low - High
80.36
92.97
Source: Capital IQ and team estimate
The transaction method also implies the same target price
In the year 2011, three companies that operated in the cloud industry were acquired and taken
private. These companies have either lower growth or less profitability than Rackspace (Table
12). We assumed a 27x TEV/EBITDA (before transaction) for Rackspace, with consideration
of its much higher growth and profitability, increasing market share, and consolidation potential.
Table 12: Comparable Transactions
Target
Savvis, Inc.
Terremark Worldwide, Inc.
NaviSite, Inc.
Rackspace Hosting, Inc.
Acquirer
CenturyLink, Inc.
Varizon Communications, Inc.
Time Warner Cable, Inc.
TTM EV/EBITDA Revenue 3 yr CAGR Net Profit Margin Market Share
12.93x
7.1%
-2.2%
5.7%
22.12x
28.3%
-5.8%
1.3%
12.00x
-2.8%
-9.0%
1.0%
*27.00x
27.2%
7.9%
6.7%
Source: Capital IQ, *team estimate
After discounting a 25% control premium, the one-year target price of Rackspace is estimated
at $91.18, which is consistent with the price derived from the previous two methods.
6
Rackspace Hosting, Inc. (NYSE: Rackspace)
Discounted Cash Flow (DCF)
Table 13: Rackspace WACC: 11.3%
Key Assumptions in WACC
Tax Rate
Levered Beta
Risk-free Rate
Equity Risk Premium
Company-Size Risk Premium
Company-Specific Risk Premium
35%
1.33
1.82%
5.92%
0.78%
1%
Source: www.treasury.gov; Ibbotson, and team estimates
Table 14: Rackspace as % of U.S. Managed Hosting Market
($mm)
2011A 2012E 2013E 2014E 2015E 2016E
Managed hosting rev in
% of U.S. Hosting
infrastructure services
7.4%
8.3%
9.1%
9.8%
10.6%
11.4%
Managed hosting rev in
% of global Hosting
infrastructure services
2.7%
3.0%
3.3%
3.5%
3.8%
4.0%
22.9%
20.2%
17.1%
16.3%
14.7%
13.9%
$156
$169
$171
$192
$201
$218
7.5%
8.0%
7.9%
8.5%
7.6%
7.3%
$51
$67
$79
$100
$104
$115
33%
40%
46%
52%
52%
53%
$105
$102
$92
$92
$97
$103
67%
60%
54%
48%
48%
47%
RAX Rev y/y growth
Dollar Growth
Estimated Growth in
Complex Managed
Segment*
Incremental Dollar
Growth from market
Growth
% of Dollar Growth
Incremental Dollar
Growth from Share Gain
% of Dollar Growth
Source: IDC and team estimates
4.5%
3.5%
2.5%
1.5%
0.5%
-0.5%
2007
2008
2009
2010
2011
IB Growth
Churn
Net upgrades
Source: Company reports and team estimates
Figure 16: Rackspace Public Cloud Segment is Expected to
Significantly Benefit from Total Market Growth and Current
Customers’ Organic Growth
100%
10.0%
80%
60%
5.0%
40%
20%
0%
2011A
0.0%
2012E
2013E
2014E
2015E
2016E
Incremental Dollar Growth from Share Gain
Incremental Dollar Growth from Market Growth
Incremental Dollar Growth from Installed Base
Public Cloud rev as % of Global Market Share (Right Axis)
Source: Company reports, Gartner, and team estimates
Managed Hosting (Dedicated Cloud) Growth Estimation
Rackspace has consistently gained market share from the fragmented market and is
estimated to maintain this momentum and reach 12% of the U.S. market in 2016
Rackspace has continuously gained 1% - 2% market share in the U.S. hosting infrastructure
service market because it provides “Fanatical Support” – a better service model – and a
competitive pricing strategy. The traditional in-house hosting segment, as we believe, belongs
to the “other” category. It diminishes nearly 9% to third party solutions because it lacks
“CAPEX to OPEX” benefits, scalability, up-to-date technology talents, and the possibility to
reallocate resources from IT spending to core business activities.
Rackspace is projected to outperform competitors with an 16% CAGR through 2016
We estimate Rackspace will represent 11.4% of the U.S. hosting infrastructure services
market share and 4% of global market share in 2016 with an 15.5% CAGR growth rate based
on three primary assumptions (Table 14). (1) The managed hosting segment is a mature
market with 7.5% growth rate in the U.S. and 8.2% globally. Rackspace’s growth rate will
approximate the industry growth rate as the market finishes consolidating. (2) We break down
Rackspace’s managed hosting incremental revenue to share gains and market growth. The
result indicates that Rackspace is able to maintain its momentum to gain share, and benefit
from the market growth at the same time. (3) Cloud solutions is expected to drive away some
customers from the managed hosting players and slow down the growth rate.
Rackspace, as we estimate, will benefit from its established local supporting Racker teams
and sales channels to enter the European market. Due to its competitive advantages,
Rackspace should be able to attract additional market share from its competitors as well as
overall expending market. Although the managed hosting market is mature, Rackspace’s
managed hosting segment is still expected to outperform the market in our forecasting period.
Public Cloud Growth Estimation
We believe that in 2016, Rackspace will represent 7% of the global public cloud market
with a 53% CAGR, primarily due to market expansion
Rackspace’s public cloud segment will grow from 4.4% global market share in 2011 to 6.9% in
2016 due to three factors. (1) Rackspace will generate the growth from existing customers’
organic growth. (2) It will gain from total market growth, which is a main contributor projected
by Gartner. (3) It will take more market share from its competitors, as we believe the business
model and OpenStack will continue to support Rackspace during the forecasted period.
Figure 15: Rackspace Installed-base Growth and Churn
-1.5%
A discounted debt-free cash flow model with a five-year horizon was used to forecast
Rackspace’s target price. The model generates a target intrinsic value range at $81.47 –
$92.02 for 12/31/13. Rackspace closed at $78.93 on 01/25/13, suggesting significant market
appreciation.
The organic growth from existing customers is projected to represent 17% of total revenue
growth in FY12 to 15% in FY16. Total market expansion is expected to represent more than
69% of average annual revenue growth through FY16. On average, 13% of total revenue
growth is represented by share gains from other existing players. We believe that Rackspace
will benefit from OpenStack and should expand its addressable market after 2013. Thus,
Rackspace will be able to continue seizing market share from other players despite fierce
competition.
We estimate organic growth from existing customers will continue contributing to
double-digit growth to Rackspace’s public cloud: 17% in 2012, 16% in 2013, and 15% in
2014
Rackspace’s reports disclose three valuable metrics to determine the organic growth from its
existing customers: net upgrades, churn rate, and growth in its installed base (Figure 15).
These three metrics are mainly derived from the public cloud segment based on three reasons
(Figure 16). (1) Only cloud services have the property to permit users to immediately upgrade
their computing ability and storage size. This should contribute to the majority of Rackspace’s
recorded net upgrades. (2) Traditional managed hosting users do not have enough incentives
to sign up new contracts, which, according to Rackspace’s management, are usually three
years long. Customers of Rackspace can easily upgrade their resources by using the hybrid
7
Rackspace Hosting, Inc. (NYSE: Rackspace)
Figure 17: Rackspace’s Revenue Growth Estimates
360%
52%
270%
40%
180%
28%
90%
16%
0%
4%
2008A2009A2010A2011A2012P2013P2014P2015P2016P
Public cloud growth rate (left axis)
Managed hosting growth rate (right axis)
Source: Company reports and team estimates
cloud service to store sensitive data and common data separately. (3) New OpenStack
standards allow users to switch their service providers more easily than before, which we
believe is the major contribution to Rackspace’s churn rate. It is not easy for long-term
contracts on managed hosting customers to end them once they have set up their database
with Rackspace because of the time and cost for switching data from server to server. Even if
they choose to end the contracts, since no single customer represents more than 2% of
Rackspace’s revenue, it should not significantly affect the churn rate.
Short-term Preview: 4Q12 Revenue is modeled at $355.6M, y/y up 18.1% in dedicated
cloud (DC) and 54.2% in public cloud (PC)
We assume lower increments of DC and PC service revenue in 4Q12 from previous years due
to slower global demand, tensions in the Eurozone, and worries about the “fiscal cliff” in the
U.S. Another reason is that we observed a downtrend in 4Q11 as compared with 3Q11.
Therefore, we assign a lower growth 26.7% to 4Q12 (Table 15).
Table 15: Rackspace Short-term Growth Preview
Revenue & EPS
FY11
Dedicated Cloud Revenue
835.9
y/y Growth
22.9%
Public Cloud Revenue
189.2
y/y Growth
87.9%
Total Revenue
1,025.1
y/y Growth
31.3%
Earnings per Share
0.55
y/y Growth
57.1%
3/31
192.9
20.9%
37.1
92.6%
230.0
28.6%
0.10
42.9%
6/30
204.3
24.5%
43.0
85.0%
247.2
32.0%
0.13
62.5%
9/30
213.9
23.7%
50.7
89.3%
264.6
32.5%
0.14
55.6%
12/31
FY12
224.8 1,005.1
22.6% 20.2%
58.5
306.9
86.1% 62.2%
283.3 1,312.0
31.9% 28.0%
0.18
0.75
80.0% 36.4%
3/31
236.6
22.7%
64.8
74.5%
301.4
31.0%
0.17
70.0%
6/30
246.4
20.6%
72.6
69.0%
319.0
29.0%
0.18
38.5%
9/30
256.6
19.9%
79.4
56.7%
336.0
27.0%
0.19
35.7%
12/31
FY13
265.5 1,176.5
18.1% 17.1%
90.1
485.8
54.2% 58.3%
355.6 1,662.4
25.5% 26.7%
0.21
1.11
16.7% 48.4%
3/31
278.0
17.5%
104.5
61.4%
382.5
26.9%
0.24
39.4%
6/30
289.0
17.3%
116.0
59.9%
405.1
27.0%
0.25
41.1%
9/30
300.2
17.0%
124.9
57.2%
425.0
26.5%
0.29
53.2%
12/31
309.3
16.5%
140.4
55.8%
449.7
26.5%
0.33
57.6%
Source: Company reports and team estimate
Long-Term Growth Driver
Rackspace forecasts its long-term steady state revenue growth rate at 5% – 10%. We predict
it will take at least 10 – 15 years to reach that point, because we see the same duration in the
IT outsourcing industry as well. We believe Rackspace has a very strong revenue driver in its
“Fanatical Support.” Because cloud computing seems to be intangible for customers, they
have a tendency to pay a premium for a comprehensive service rather than rely merely on
storage space with potential costs on maintenance.
Discount Rate
Figure 18: Discounted Cash Flow Sensitivity Analysis:
$86.54
12.3%
11.8%
11.3%
10.8%
10.8%
Terminal TEV / EBITDA Multiple
10.0x
10.5x
11.0x
11.5x
76.44
80.09
83.73
87.37
77.76
81.47
85.18
88.89
79.12
82.89
86.67
90.44
80.50
84.34
88.18
92.02
80.50
84.34
88.18
92.02
12.0x
91.02
92.60
94.21
95.87
95.87
Source: Team estimates
Age
41
54
NA
48
68
41
54
60
51
49
Source: Company reports
Positions
CEO and Director
Director
CTO
Chairman of the Board
Lead Director
President, CSO, Director
Director
Director
Director
Director
Terminal Multiple (TEV/EBITDA: 11x)
We believe the cloud business will simulate the maturing process of IT outsourcing industry,
which has a median of TEV/EBITDA 8.6x and a mean of 11.0x in the trailing data. Since the
cloud industry is far from maturity, we add a 30% premium on the median multiple of IT
outsourcing in our DCF model. We also believe that Rackspace will continue outperforming
the cloud market. As Rackspace CEO Lanham Napier mentioned in the last conference call,
the higher service level Rackspace provides, the more potential it has to increase margins and
multiples. Therefore, we project a terminal TEV/EBITDA multiple at 11x (Figure 18). This is
also the lowest EBITDA multiple among the comparable companies, which falls into a
reasonable range.
Management Quality
Table 16: Rackspace’s Management Team
Name
A. Lanham Napier
George J. Still, Jr.
John Engates
Graham Weston
Palmer L. Moe
Lew Moorman
S. James Bishkin
Fred Reichheld
Mark P. Mellin
Michael Sam Gilliland
OpenStack is also considered as a key driver. Rackspace recently released seven products
based on OpenStack (Figure 13). Installed in customers’ datacenters or vendors’, these
products can help Rackspace ensure its sophisticated services in providing IaaS. Therefore,
OpenStack may help Rackspace change the game of the cloud market in the future.
Since
2001
2013
2000
2001
2001
2011
2005
2008
2009
2011
In our view, the Rackspace management team contains a diverse portfolio of expertise that
can guide the company in the right direction. CEO Lanham Napier is the director of
Rackspace’s unique culture. He helped identify “Fanatical Support” as the way to differentiate
Rackspace from its competitors and formalized the idea that Rackspace’s mission is to be one
of the world’s best service providers. Director George J. Still, a well-connected and successful
investor, will help direct Rackspace’s mergers and acquisition strategies in capital markets.
CTO John Engatesrole will drive the innovation and technologies that benefit Rackspace’s
hosting customers around the globe. As the biggest investor in Rackspace, Graham Weston
contributes greatly to the company’s strategic planning and business development. A team,
rather than one specific person, manages Rackspace. Nearly half the management team has
8
Rackspace Hosting, Inc. (NYSE: Rackspace)
Figure 19: Managed Hosting Porter Five Forces
been with the company for more than 10 years.
Investment Risks
4Q12 revenue and earning may be affected by slow demand
Prospects in the Eurozone are unpredictable. Risk of a perennial recession still exists and
more time is needed to build up confidence in the area. The U.S. was affect by the “fiscal cliff”
in 4Q12 as concern about the issue may result in slower demand for Rackspace’s services.
Therefore, there is possibility that Rackspace may miss Wall Street Analysts’ estimates for the
4Q12 results.
Source: Team estimates
Figure 20: Public Cloud Porter Five Forces
Failure in Rackspace physical infrastructure or services could lead to significant costs
and disruptions of its business
Infrastructure is the most basic support for Rackspace business, and there are various risks
that could lead to the failure of its infrastructures. Possible risks would include power loss,
routing problems, human accidents, natural disasters, and other related events. Infrastructure
failures could cause the company to reimburse its customers’ losses and affect its reputation
as a reliable service provider.
Rackspace could fail in such a highly competitive industry
The managed hosting industry has existed for decades. There are still many players in this
game. Although Rackspace is rapidly gaining its market share in this industry, being able to
sustain its current growth rate will be challenging. Any significant mistakes can negatively
impact this young company.
We see a promising future in this industry but it faces immense competition from: DIY
solutions with a colocation partner (AT&T, Equinix, and CenturyLink), IT outsourcing providers
(CSC, HP, and IBM), and hosting providers (British Telecom, Softlayer, and Verio).
Source: Team estimates
Figure 21: Estimated Rackspace Employee Numbers
12,000
10,000
8,000
6,000
4,000
2,000
2010 2011 2012 2013 2014 2015 2016
Source: Company reports and team estimates
Acquisitions may distract Rackspace management attention, resulting in fewer
consumer resources than are necessary to sustain its business
Rackspace has made several acquisitions in the past and we believe it will continue acquiring
smaller companies. Primarily predicted on its former purchases, we foresee product-focused
transactions rather than large-market, share-gaining, or transformational deals. In future
acquisitions, Rackspace could encounter problems in assimilating operations, consolidating
services and technology, and maintaining controls and policies.
Failure to keep recruiting and retaining talented employees and managers will
deteriorate service quality and harm operations
Rackspace’s entire service business relies heavily on its ability to hire, train, and retain
qualified employees. A shortage in qualified personnel will impair the company’s business
model and operations. We are concerned with three aspects about Rackspace’s future
success in terms of recruitment. (1) Rackspace may not able to reach a projected 161%
increase in its employees. In FY11 and FY12, each employee generated $272.8K and
$287.7K revenue respectively. In FY16, we estimate that Rackspace will need to have 11,975
employees (1.6x increase) to support forecasted $3.47B revenue. (2) Rackspace has a $68K
average salary compared with Apple’s $108K and Google’s $106K. This relatively low level of
average salary may not be able to continue attracting new employees. (3) Management
disclosed that Rackspace would not outsource its service to low-cost countries.
Concluding Comments
Rackspace delivers solid financials and demonstrates high growth potential. It is gaining
market share in the managed hosting industry and has grown quickly in the public cloud
industry. Its business is differentiated by superior services, backed by innovative technology,
and sustained by strong management and culture. Our valuation analysis derives a one-year
target price of $90.07. Therefore, we are initiating a BUY recommendation.
9
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 1.
SWOT Analysis
Strengths:
Superior “Fanatical Support” service
Rackspace differentiates itself by the “Fanatical Support” service. It enables clients to make strategic IT transitions without the IT
department. It helps Rackspace achieve long-life revenue generation (56 month of stay per customer) and low churn rate (0.9%).
Rackspace is one of the few companies that offer SLA that would refund up to 100% of the customer’s bill if it does not maintain its
100% uptime guarantee.
Great and strong company cultures help to attract excellent employees and maintain culture branding.
The company has been widely recognized for its unique use of ‘Culture Branding’ that helps Rackspace to maintain its talented team
and its “Fanatical Support” services. Rackspace ranked 74 on FORTUNE magazine’s annual list of the “100 Best Companies to Work
For” in 2012 and has been on the list four times in the past five years. Being a very attractive place to work, Rackspace hires “A
players” in the market (Rackspace hires only about 1% of its applicants, compared with 7% in Harvard University study).
Predictable and sustainable success-based front loaded CAPEX
Given that the nature of the cloud-hosting business is very capital intensive, Rackspace has been able to minimize the risk.
Rackspace only builds out data center space if it expects a customer to utilize it, resulting the cash outflow closely matched with inflow.
The level of debt to assets is about 13%, considered very low in the industry. Data centers are built on leased spaces rather than
owned facilities, thus, reduces front-loaded CAPEX spending.
Weaknesses:
OpenStack code is arguably unstable and has several governance issues
There are complaints about difficulty in the installment of several test drives. OpenStack has experienced lower availability as
compared with other established platforms. Since Rackspace released OpenStack to an independent foundation, it drew complaints
that it had disproportionate influence over direction and governance issues.
Cannibalization of managed hosting business
The public cloud IaaS could be a candidate for managed hosting business since they offer a similar value proposition and service. The
public cloud might attract some existing customers since it is usage is not based on a monthly subscription.
Opportunities:
Large potential market in both the managed hosting industry and public cloud
Rackspace will focus on the current $7.5B managed hosting business and is estimated to remain the market leader. In the public
cloud, small businesses in the U.S. spent $3.5B on cloud technology in 20112. In the dedicated hosting business, there is also a
$432B outsourcing market for potential share gain. Rackspace is competing well by gaining 1%-2% market share per year.
High growth rate in the international market
Rackspace CEO mentioned “Our next set of investments will be in AsiaPacific because the demographics are good.” In 2011, North America
generated the most cloud traffic, followed by Asia Pacific and Western
Europe. By 2016, Asia Pacific will generate the most cloud traffic3, as the
graph estimates.
OpenStack opens the door for Rackspace to increase revenue
position and develop a new market.
OpenStack reduces Rackspace’s dependence on VMWare’s vCloud and
Amazon’s Web Services. It increases Rackspace’s scalability and ability
to host larger clients. With the technology of OpenStack, Rackspace will
be able to sell “Fanatical Support” outside their data centers.
1.6
1.2
0.8
0.4
0
2011(in 1000
Exabytes)
Asia Pacific
2016(in Zettabytes)
North America
CAGR(%)
West Europe
Threats:
Internal execution with rapid growth
The management team’s biggest concern is internal execution. Rackspace is growing at a faster rate than historical. There can be
2
3
International Data Corp., a technology research firm.
Second annual Cisco® Global Cloud Index (2011-2016)
10
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
many problems involved with operation, execution and management. Also, they are afraid that the culture might not be maintained.
Intense competition on all levels
Rackspace faces competition from many aspects but the following three discussed below are most intense:
 Competition on industry standards. There is a war going on between open standard and closed proprietary technologies.
Rackspace is facing intense competition from big technology companies on the closed proprietary side, such as Amazon, Google
and Microsoft, who are backed by deep pocketed development money and are building their empire at a full speed.
 Competition within the industry. The open source technology is a natural add-on product for co-location and network companies,
that provide little barriers to entry. Though Rackspace is the leader in Open cloud technology and making itself as a specialist, it
faces potential threat from many telecom companies that offer OpenStack based services on their existing data center. Should
Rackspace lose the technology advantage, it may be forced to play a pure service game again.
 Price war. Rackspace’s superior “Fanatical Support” service requires a larger revenue margin for support. It might become
difficult to avoid a price war given that cloud major player AWS has had roughly 24 price cuts over the years, Google had two
recently, and many emerging cloud service companies are trying to match the service with lower price (joycent, cloudluca, citrix,
etc.)4 .
Security breach and service disruptions.
Security issue is the biggest concern for companies trying to move to Cloud. For example, Amazon service had a serious disruption on
Christmas Eve. Rackspace has a 100% guaranteed service agreement, which will credit clients if any failure occurs. As it moves to
larger clients, the potential service outages could result in a huge loses to Rackspace.
Rapid technology change
New revolutionary technologies may arise in the future that can substitute the traditional managed hosting industry These innovations
can change the industry quickly. For example, HP EcoPOD, an ultra-efficient and self-contained data center can also address
company IT needs in a more efficient and perhaps easier manner.
4www.nbvp.com
11
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 2.
Market consolidation life cycle
Source: Harvard Business School
12
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 3.
Rackspace vs. Competitors
Competitors
Datapipe
Advantage
Faster global presence
SoftLayer
Savvis
IBM
Disadvantage
Tie
Limited service & Lack of
expertise
No management services
Have strong focus
above the OS
Aggressive in foundation
hosting and cloud
Limited resources
services
Deep technology
resources and broad data
center presence
GoGrid
Tier 3
Difference
Diversified technology
company
Strong Service-Level
Agreements (SLAs)
Emphasizes on whitelabel and reseller
capabilities
Competitors’ Profile:
Amazon competes in the public cloud IaaS space by offering low-price Do-It-Yourself (DIY) products. It focuses on commoditized
public cloud market, which offers highly automated, cost-effective IT solutions. We believe AWS will attract more enterprises that have
IT expertise, and will not compete directly with Rackspace.
Datapipe is a smaller, fast growing and independently managed hoster and cloud IaaS provider. It collaborates with Amazon and
RightScale, which help to increase Datapipe’s global presence at a faster rate than Rackspace . However, with limited expertise and
customer service, the large portfolio of services that Datapipe offers could easily confuse enterprise customers.
SoftLayer is an independent web hoster focusing on SMBs. It continues investing and building market-leading automation and selfservice capabilities. Although SoftLayer is as focused as Rackspace in the SMB market, it does not provide other management
services above the OS (Operation System), making it less capable on business process.
Savvis is a cloud and managed hoster focus on delivering IT services to business and government enterprises. Savvis maintains a
very aggressive expansion plan for foundation hosting and cloud services. Acquired by CenturyLink, the expansion may be restricted
by capital funding, sales resources, and marketing resources within CenturyLink.
IBM is a highly diversified technology company. It offers co-location (on a limited basis), managed hosting, ERP hosting, and cloud
IaaS. Given IBM’s deep technology resources and broad data center presence, we believe IBM can leverage its large/multi-national
customer base to grow its business. Rackspace will compete with IBM in the enterprise market.
GoGrid is a small, independent cloud-IaaS-focused provider in VMware platform (non-open source). Like Rackspace, it has
transitioned from a traditional hoster to cloud service provider. It also offers hybrid hosting solutions supported by dedicated service
and strong Service-level Agreements (SLAs). However, customers’ preference on whether a platform is an open source or not will
guide their selections between Rackspace and GoGrid.
Tier 3 is a small, independent service provider that focuses solely on cloud services. It combines a good set of features on a wellengineered platform with an easy-to-use self-service portal. Tier 3 emphasizes on white-label and reseller capabilities.
13
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 4.
Open Source vs. Closed Source
Source: Cloud spectator
14
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 5.
Performance Comparison
Source: Cloud spectator
15
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 6.
Rackspace Cloud vs. Amazon EC2
Size of sever
Small
Medium
Large
Extra Large
Memory
AMZN Rackspace
1700MB
3750MB
7500MB
15000MB
512MB
1024MB
2048MB
4096MB
8192MB
1500MB
3000MB
Cost / Hour ($)
AMZN Rackspace
N/A
N/A
0.090/hr
0.180/hr
0.360/hr
0.720/hr
N/A
0.022/hr
0.06/hr
0.12/hr
0.24/hr
0.48/hr
0.90/hr
1.20/hr
Source: Amazon & Rackspace
16
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 7.
The U.S. Hosting Infrastructure Service Market Share Distribution
U.S. Hosting Infrastructure Service Market Share Distribution
2009
2010
IBM Global Services
10.1%
9.9%
AT&T
7.1%
7.5%
Rackspace
4.5%
5.4%
HP
6.6%
6.4%
Equinix
4.2%
5.7%
SAVVIS (now part of CenturyLink)
5.4%
5.7%
Verizon Business
3.6%
3.8%
Softlayer
0.9%
1.3%
SunGard Availability Services
1.9%
1.8%
CenturyLink/Qwest
1.8%
1.8%
GoDaddy
1.2%
1.4%
CSC
1.5%
1.5%
Terremark (now part of Verizon Business)
1.6%
1.9%
Verio
1.2%
1.2%
Internap
1.1%
1.1%
Yahoo! Small Business
1.2%
1.1%
Level 3
0.9%
1.0%
NaviSite/Time Warner Cable
1.1%
0.9%
Web.com
1.0%
0.9%
Switch & Data (Now Part of Equinix)
1.3%
NA
Other
41.9%
39.6%
Total
100%
100%
2011E
10.7%
8.4%
7.4%
6.5%
6.3%
5.7%
4.2%
3.1%
1.9%
1.9%
1.9%
1.5%
1.3%
1.2%
1.1%
1.1%
1.0%
1.0%
0.9%
NA
32.9%
100%
Source: IDC, J.P. Morgan estimates, and Team estimates
17
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 8.
RAX's Public Cloud is Expected to Significantly Benefit from Total Market Growth and
Current Customers' Organic Growth
$ million
2011A 2012E 2013E 2014E 2015E 2016E
Public Cloud rev in % of
4.0%
4.8%
5.5%
6.4%
7.4%
8.4%
Global Market Share
RAX Public Cloud y/y Growth
87.9% 62.2% 58.3% 56.7% 53.6% 44.1%
Dollar Growth
$ 88.5 $ 117.7 $ 179.0 $ 275.5 $ 408.1 $ 515.7
Net Upgrades
Churn
Growth in Installed Base
Incremental Dollar Growth
from Installed Base
% of Dollar Growth
Estimated IaaS Market Growth
Incremental Dollar Growth
from Market Growth
% of Dollar Growth
Incremental Dollar Growth
from Share Gain
% of Dollar Growth
22.8%
-10.8%
12.0%
20.4%
-9.6%
10.8%
19.7%
-10.0%
9.7%
19.0%
-10.4%
8.6%
18.3%
-10.8%
7.5%
17.6%
-11.2%
6.4%
$ 12.1 $ 20.4 $ 29.8 $ 41.8 $ 57.1 $ 74.8
13.6%
17.4%
16.6%
15.2%
14.0%
14.5%
51.2%
35.9%
36.6%
34.8%
33.4%
27.7%
$ 51.5 $ 67.9 $ 112.4 $ 169.1 $ 254.5 $ 323.5
58.2%
57.7%
62.8%
61.4%
62.4%
62.7%
$ 24.9 $ 29.3 $ 36.8 $ 64.5 $ 96.5 $ 117.4
28.2%
24.9%
20.5%
23.4%
23.6%
22.8%
Source: Company reports, Gartner, IDC, and team estimates
18
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 9.
CAPEX components and relation with incremental revenues
Revenue
dollar increase
FY2009
628,987
97,054
FY2010
780,555
151,568
Maintenance Capex
Growth Capex
Total Capital Expenditure
130,038 70.0%
55,636 30.0%
185,674 100.0%
142,692 66.0%
73,449 34.0%
216,141 100.0%
Dollar revenue increase from $1
spent on growth capex
$1.74
$2.06
FY2011
1,025,064
244,509
226,854 65.8%
118,041 34.2%
344,894 100.0%
$2.07
Source: company report and team estimate
19
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 10.
DuPont Analysis
Factorization
FY
2011
2010
Return on Equity 2009
2008
2007
2011
2010
Profit Margin
2009
2008
2007
2011
2010
Asset Turnover
2009
2008
2007
2011
2010
Leverage Ratio
2009
2008
2007
RAX
AKAM
EQIX
CTXS
RHT
15%
12%
10%
12%
21%
7.5%
5.9%
4.8%
4.1%
4.9%
1.15x
1.10x
0.90x
1.10x
1.70x
1.74x
1.82x
2.27x
2.62x
2.56x
9.30%
8.70%
8.80%
9.90%
8.70%
17.30%
16.70%
17.00%
18.40%
15.90%
0.50x
0.50x
0.40x
0.40x
0.40x
1.07x
1.04x
1.29x
1.35x
1.37x
4.70%
2.40%
6.60%
12.50%
-1.70%
5.90%
3.00%
7.90%
15.30%
-2.40%
0.30x
0.30x
0.30x
0.30x
0.30x
2.77x
2.67x
2.78x
2.72x
2.36x
13.49%
11.60%
9.30%
9.50%
13.00%
16.10%
14.80%
11.80%
11.30%
15.40%
0.60x
0.60x
0.60x
0.60x
0.60x
1.40x
1.31x
1.31x
1.40x
1.41x
10.87%
8.90%
7.90%
7.70%
8.70%
12.90%
11.80%
11.70%
12.10%
14.70%
0.50x
0.40x
0.40x
0.30x
0.30x
1.69x
1.89x
1.69x
2.12x
1.97x
Source: Capital IQ and team estimates
20
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 11.
Comparable Companies’ Ratios Analysis
2011
RAX
AKAM
EQIX
CTXS
RHT
1.1
7.56
1.7
1.16
1.48
RAX
AKAM
EQIX
CTXS
RHT
1.1
0.49
0.31
0.57
0.48
RAX
AKAM
EQIX
CTXS
RHT
28.6
66.6
40.93
22.11
20.41
RAX
AKAM
EQIX
CTXS
RHT
14.7
9.27
4.91
13.49
10.87
2010
2009
2008
Current Ratio
1
1.2
2.2
5.91
2.33
5
2.45
2.31
1.31
1.44
1.25
1.29
1.74
1.77
1.99
Total Asset Turnover
1.1
0.9
1.1
0.46
0.43
0.45
0.33
0.32
0.3
0.55
0.56
0.6
0.45
0.41
0.34
EBITDA Margin %
28
27
23.1
64.24 67.95 68.93
36.79 40.16 33.15
20.51
15.4 14.94
19.35 18.37 22.87
ROE %
11.8
9.8
11.8
8.74
8.82
9.89
2.41
6.69 15.37
11.69
9.3
9.47
8.93
7.87
7.65
2007
2011
0.5
7.86
2.23
1.43
1.23
1
7.14
1.46
1.04
1.29
1.7
0.44
0.28
0.61
0.27
17.6
6
12.21
5.11
5.14
22.6
60.59
25.58
20.63
28.83
12.6
32.3
19.6
19.2
16
21.3
8.73
-0.89
12.99
8.63
11.88
12.3
4.3
10
9.3
2010
2009
2008
Quick Ratio
0.8
1.1
2.1
5.39
2.2
4.68
2.24
2.1
1.13
1.25
1.08
1.1
1.54
1.59
1.77
Receivables Turnover
18.1
18.1
18.9
6.21
5.85
6.1
12.95
13.2 11.11
5.49
6.02
6.91
5.6
5.57
5.1
EBIT Margin %
11
9.8
8.4
27.8
28
28.9
17.5
20.4
11.3
17.3
12.7
10.8
14.6
12.6
13.5
ROC %
9.2
6.4
6.4
8.1
7.6
8.1
4
4.7
2.5
8.5
6.2
5.7
7.6
3.9.
3.9
2007
2011
0.5
7.53
2.16
1.23
1.15
12
N/A
136.3
N/A
N/A
17.4
6.2
9.65
6.46
4.85
N/A
35.86
89.64
35.62
32.53
9
24.5
2.2
15.2
13.1
7.5
17.3
5.9
16.1
11.8
12.8
6.7
0.4
8
3
8.6
8.55
1.84
9.13
6.24
2010
2009
2008
D/E Ratio %
16
33.2
94.8
N/A
N/A
12.7
107.5 120.8 124.2
N/A
N/A
N/A
N/A
N/A
N/A
Payable Turnover
N/A
N/A
N/A
40.64 38.08 39.73
88.88 53.16 42.41
30.43 31.03 30.88
25.91 26.73 23.38
Profit magin %
5.9
4.8
4.1
16.7
17
18.4
3
7.9
15.3
14.8
11.8
11.3
11.7
12.1
14.7
ROA %
7
5.1
5.1
7.71
7.35
8.18
0.99
2.53
5.67
8.16
6.6
6.8
5.27
4.81
4.11
2007
86
14.7
133.3
N/A
N/A
N/A
30.92
43.4
27.62
17.96
4.9
15.9
-2.4
15.4
15
8.8
6.95
-0.35
9.41
3.96
Source: Capital IQ and team estimates
21
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 12.
T1
T2
T3
T4
Z Score
Z Score
2008
2009
2010
2011
0.299
0.127
0.076
0.090
0.163
0.114
0.162
0.203
0.225
0.247
0.059
0.083
0.105
0.120
0.131
3.069
5.846
14.763
21.644
15.768
5.948
8.052
17.365
24.859
19.314
Analysis of Z Score On Financial Figures
Z Score above 2.6
Z Score between 1.1-2.6
Z Score below 1.1
LTM 3Q12
Safe
Caution and on alert
Bankrupcty highly likely
T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
Z score=6.56T 1+3.26T 2+6.72T 3+1.05T 4
22
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 13.
F Score
Joseph Piotroski F-Score F actors
1. Is Net Income Positive? (100.6)
2. Is Operating Cash flow Positive? (397.1)
3. Is Operating Cash flow greater than Net Income?(397.1>100.6)
4. Has Return on Assets increased (from the prior year)?(9.2>8.2)
5. Has Gross Margin improved? (71.4>69.8)
6. Has Asset Turnover improved? (1.15<1.12)
7. Has LT Debt/ Total Assets decreased?(10<12)
8. Has the Current Ratio improved? (1.5>1.1)
9. Has there been no new equity issuance?
1
1
1
1
1
0
1
1
0
Total Score
Comparisons based on LTM 3Q12 VS 2008
8
23
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 14.
Short Interest
Price
Volume (mm)
Shares Sold Short (mm)
Short Interest as % of Shares Out.
Latest
76.31
1.9
9.36
6.83%
As of 1/24/13
79.24
1.98
10.08
7.36%
Change (%)
-3.70%
-4.40%
-7.19%
-7.19%
Source: Capital IQ
24
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 15.
Shares Ownership
Share Ownership Summary
Type
Institutions
Individuals/Insiders
Public and Other
Total
Common Stock % of Total Market Value
Equivalent Held Shares Out.
(MM)
108,191,284
79.00
8,256.1
25,358,941
18.52
1,935.1
3,397,775
2.48
259.3
136,948,000
100.00
10,450.5
Source: Capital IQ
Institutional Ownership Details
Type
Traditional Investment Managers
Banks/Investment Banks
Government Pension Sponsors
Hedge Fund Managers (<5% stake)
Family Offices/Trusts
Educational/Cultural Endowments
Corporate Pension Sponsors
Sovereign Wealth Funds (<5% stake)
VC/PE Firms (<5% stake)
Insurance Companies
Total
Common Stock
% of Inst.
Equivalent Held Ownership
99,064,973
91.56
4,051,089
3.74
2,646,459
2.45
2,003,111
1.85
144,776
0.13
135,559
0.13
117,108
0.11
14,100
0.01
10,576
0.01
3,533
0.00
108,191,284
100.00
% of Total Market Value
Shares Out.
(MM)
72.34
7,559.7
2.96
309.1
1.93
202.0
1.46
152.9
0.11
11.1
0.10
10.3
0.09
8.9
0.01
1.1
0.01
0.8
0.00
0.3
79.00
8,256.1
Number Of
Holders
274
27
19
17
14
1
3
1
1
1
358
Source: Capital IQ
25
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 16.
Comparable Companies Profile
Company Name
Akamai Technologies, Inc.
Equinix, Inc.
Citrix Systems, Inc.
Red Hat, Inc.
Rackspace Hosting, Inc.
Ticker
AKAM
EQIX
CTXS
RHT
RAX
Share Price Mkt Cap (MM) TEV (MM) D/E ratio TTM EBITDA % EBITDA 3 Yr CAGR
41.15
7,303
6,838
40.0%
13.8%
225.25
10,829
13,459 127.89
42.4%
33.3%
71.55
13,360
12,677
23.7%
21.7%
56.05
10,826
9,942
20.6%
21.8%
78.93
10,809
10,702
19.20
30.0%
32.3%
Source: Capital IQ and company reports
General description of comparable companies
Akamai Technologies, Inc. (AKAM): provides content delivery and cloud infrastructure services for accelerating and improving
applications over the Internet in the United States and internationally. Most of its revenues come from CDN, and the remaining 1/3 are
from its cloud infrastructure services.
Equinix, Inc. (EQIX): offers data center services, including premium data center collocation services; interconnection services
comprising physical cross-connect/direct interconnections, Internet exchange, metro connect, Internet connectivity services, and
Ethernet exchange services; and outsourced IT infrastructure services. (Listed as a competitor by Rackspace)
Citrix Systems, Inc. (CTXS): offers desktop solutions as its main products, and provides datacenter, cloud solutions, and software as
services.
Red Hat, Inc. (RHT): provides open source software solutions to enterprise customers, it also provides enterprise technologies,
various cloud, storage, and systems management offerings, as well as offers training, consulting, and support services.
26
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 17.
Financial Modeling Assumptions
Rackspace Hosting Inc. Financial Modeling Assumptions
($ in millions, except per share items)
Income Statement Drivers / Assumptions
Dedicated Cloud Revenue Growth Rate
Public Cloud Revenue Growth Rate
HISTORICAL VARIABLES AND DRIVERS
ASSUMPTIONS FOR PROJECTIONS
Fiscal Year Ending December 31,
Fiscal Year Ending December 31,
2007A 2008A 2009A 2010A 2011A 2012P 2013P 2014P 2015P 2016P
na 42.2% 13.0%
na 356.1% 124.8%
18.7%
78.5%
22.9%
87.9%
20.2%
62.2%
17.1%
58.3%
16.3%
56.7%
14.7%
53.6%
13.9%
44.1%
Cost of Revenue as % of Revenue
32.7%
32.4%
31.9%
32.0%
30.2%
28.0%
26.7%
27.9%
27.7%
27.2%
Depreciation and Leasehold Amortization
Amortization Expenses for Intangible Assets
15.1%
$1.8
16.1%
$4.5
18.9%
$6.5
19.2%
$6.0
18.5%
$5.6
18.9%
$6.7
18.9%
$6.1
18.9%
$5.0
18.9%
$4.3
18.9%
$3.3
SG&A as % of Sales
43.3%
43.1%
39.4%
37.8%
38.7%
39.4%
38.7%
38.0%
37.4%
37.0%
$3.6
$0.8
$8.2
$0.8
$9.0
$0.3
$8.0
($0.2)
$5.8
($1.2)
$5.8
$0.0
$5.8
$0.0
$5.8
$0.0
$5.8
$0.0
$5.8
$0.0
35.9%
33.6%
35.1%
35.1%
34.4%
35.0%
35.0%
35.0%
35.0%
35.0%
25
0.0%
$0.0
2.1%
21
2.3%
$3.1
1.5%
22
1.2%
$9.8
1.6%
22
0.6%
$6.4
2.8%
24
0.0%
$9.8
2.4%
24
0.0%
$9.8
2.1%
24
0.0%
$9.8
2.1%
24
0.0%
$9.8
2.1%
24
0.0%
$9.8
2.1%
24
0.0%
$9.8
2.1%
Work in process
Capex as % of Sales
Goodwill
Intangible Assets, net
Other Non-current Assets
$42.5 $111.1
38.8% 31.1%
$3.6
$6.9
$5.8 $15.1
$7.2
$8.7
$49.8
18.6%
$22.3
$10.8
$10.9
$68.7
18.5%
$57.1
$9.7
$14.1
$62.7
26.3%
$60.0
$26.0
$49.6
$62.7
26.2%
$68.7
$26.0
$47.2
$62.7 $62.7 $62.7 $62.7
26.7% 26.5% 26.0% 26.4%
$84.1 $100.6 $126.6 $150.3
$26.0 $26.0 $26.0 $26.0
$47.2 $47.2 $47.2 $47.2
Days Payable
Current Portion of Deferred Revenue
Non-current Deferred Revenue
Current Portion of Obligation
Non-current Obligation
Other Non-current Liabilities
204
$13.5
$4.4
$25.2
$23.3
$8.5
149
$16.3
$3.9
$38.9
$50.8
$10.2
161
$17.1
$2.3
$46.4
$63.3
$11.8
161
$15.8
$2.9
$59.8
$69.2
$10.8
182
$14.8
$3.4
$66.0
$72.2
$21.5
163
$15.5
$3.4
$71.9
$77.2
$21.5
163
$15.5
$3.4
$77.3
$82.4
$21.5
163
$15.5
$3.4
$84.1
$87.9
$21.5
163
$15.5
$3.4
$90.0
$92.5
$21.5
163
$15.5
$3.4
$95.5
$97.8
$21.5
$0.1
34%
$0.1
120%
$0.1
125%
$0.1
119%
$0.1
124%
$0.1
128%
$0.1
103%
$0.1
82%
$0.1
64%
$0.1
52%
Interest Expense
Interest and Other Income (Expense)
Tax Rate
Balance Sheet Drivers / Assumptions
Days Accounts Receivable
Income Tax Receivables % of Sales
Deferred Income Tax
Prepaid Exp. & Other CA % of Sales
Common Stock
Additional Paid-in Capital % of GOGS
27
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 18.
Income Statement Projection
Rackspace Hosting, Inc. Income Statement Projection
($ in millions, except per share items)
Cost of Revenue
COGS as % of Revenue
2007A
$356.5
na
$5.5
na
$362.0
na
$0.3
($118.2)
32.7%
Gross Profit
Gross Profit Margin %
SG&A Expenses
SG&A as % of Revenue
Dedicated Cloud, Net Revenue
% Growth
Public Cloud, Net Revenue
% Growth
Total Revenue, Net
% Growth
Fiscal Year Ending December 31
2008A
2009A
2010A
$506.9
$572.6
$679.9
42.2%
13.0%
18.7%
$25.1
$56.4
$100.7
356.1%
124.8%
78.5%
$531.9
$629.0
$780.6
46.9%
18.2%
24.1%
2011A
$835.9
22.9%
$189.2
87.9%
$1,025.1
31.3%
2012P
$1,005.1
20.2%
$306.9
62.2%
$1,312.0
28.0%
Fiscal Year Ending December 31
2013P
2014P
2015P
$1,176.5 $1,368.3 $1,569.5
17.1%
16.3%
14.7%
$485.8
$761.3 $1,169.4
58.3%
56.7%
53.6%
$1,662.4 $2,129.6 $2,738.8
26.7%
28.1%
28.6%
2016P
$1,787.6
13.9%
$1,685.1
44.1%
$3,472.7
26.8%
($172.6)
32.4%
($200.9)
31.9%
($249.8)
32.0%
($309.1)
30.2%
($367.2)
28.0%
($443.9)
26.7%
($594.2)
27.9%
($758.7)
27.7%
($944.6)
27.2%
$243.8
67.3%
$359.4
67.6%
$428.0
68.1%
$530.7
68.0%
$716.0
69.8%
$944.8
72.0%
$1,218.5
73.3%
$1,535.5
72.1%
$1,980.2
72.3%
$2,528.1
72.8%
($156.7)
43.3%
($229.0)
43.1%
($247.6)
39.4%
($295.2)
37.8%
($397.1)
38.7%
($516.9)
39.4%
($643.3)
38.7%
Depreciation and Leasehold Amortization
Amortization Expenses for Intangible Assets
($54.7)
($1.8)
($85.7)
($4.5)
($118.8)
($6.5)
($149.9)
($6.0)
($189.8) ($247.56) ($313.68) ($401.84) ($516.80) ($655.27)
($5.6)
($6.7)
($6.1)
($5.0)
($4.3)
($3.3)
Income from Operation / EBIT
EBIT Margin %
$30.6
8.4%
$40.1
7.5%
$55.2
8.8%
$79.6
10.2%
$123.5
12.0%
$173.6
13.2%
$255.4
15.4%
$319.4
15.0%
$434.7
15.9%
$584.6
16.8%
EBITDA
EBITDA Margin %
EBITDA Growth
$87.1
24.1%
na
$130.3
24.5%
49.6%
$180.5
28.7%
38.5%
$235.5
30.2%
30.5%
$318.9
31.1%
35.4%
$427.9
32.6%
34.2%
$575.2
34.6%
34.4%
$726.2
34.1%
26.3%
$955.9
34.9%
31.6%
$1,243.2
35.8%
30.1%
Interest Expense
Interest and Other Income (Expense)
Total Other Income (Expense)
($3.6)
$0.8
$2.8
($8.2)
$0.8
$7.5
($9.0)
$0.3
$8.7
($8.0)
($0.2)
$8.2
($5.8)
($1.2)
$7.0
($6.2)
$0.0
$6.2
($6.5)
$0.0
$6.5
($6.9)
$0.0
$6.9
($7.3)
$0.0
$7.3
($7.7)
$0.0
$7.7
Pretax Income
$27.8
$32.7
$46.5
$71.4
$116.4
$167.4
$248.9
$312.4
$427.4
$576.9
Taxes
Tax Rate
($10.0)
35.9%
($11.0)
33.6%
($16.3)
35.1%
($25.1)
35.1%
($40.0)
34.4%
($58.6)
35.0%
($87.1)
35.0%
($109.4)
35.0%
($149.6)
35.0%
($201.9)
35.0%
Net Income
Net Margin %
Net Income Growth
EPS - Basic
EPS - Diluted
$17.8
4.9%
-10.2%
0.18
0.17
$21.7
4.1%
21.7%
0.20
0.19
$30.1
4.8%
39.1%
0.25
0.24
$46.4
5.9%
53.8%
0.37
0.35
$76.4
7.5%
64.9%
0.59
0.55
$108.8
8.3%
42.4%
0.79
0.75
$161.8
9.7%
48.7%
1.18
1.11
$203.1
9.5%
25.5%
1.48
1.39
$277.8
10.1%
36.8%
2.03
1.91
$375.0
10.8%
35.0%
2.74
2.57
($809.3) ($1,024.3) ($1,284.9)
38.0%
37.4%
37.0%
28
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 19.
Balance Sheet Projection
Rackspace Hosting, Inc. Balance Sheet Projection
($ in millions, except per share items)
Assets
Cash and Equivalents
Accounts Receivable, Net
Income Tax Receivables
Deferred Income Tax
Prepaid Expenses and Other Current Assets
Total Current Assets
2007A
$24.9
$25.4
$0.0
$0.0
$7.8
$58.1
Work in Process
Land
$42.5
$13.9
$111.1
$13.9
$49.8
$13.9
Gross PP&E
Accumulated Depreciation
Net PP&E
$291.2
($120.5)
$227.1
$425.4
($188.3)
$362.0
Goodwill
Intangible Assets, Net
Other Non-current Assets
Total Assets
$3.6
$5.8
$7.2
$301.8
Liabilities
Accounts Payable & Accrued Expenses
Current Portion of Deferred Revenue
Current Portion of Obl. under Capital Leases
Current Portion of Debt
Total Current Liabilities
Non-current Deferred Revenue
Non-current Obligations under Capital Leases
Non-current Debt
Non-current Deferred Income Taxes
Non-current Deferred Rent
Other Non-current Liabilities
Total Liabilities
Shareholders' Equity
Common Stock
Treasury Stock
Additional Paid-in Capital
AOC Income (Loss)
Retained Earnings
Total Shareholders Equity
Total Liabilities and Equity
Fiscal Year Ending December 31
2008A
2009A
2010A
$238.4
$125.4
$104.9
$30.9
$38.7
$47.7
$12.3
$7.5
$4.4
$3.1
$9.8
$6.4
$7.8
$10.2
$22.0
$292.5
$191.7
$185.4
Fiscal Year Ending December 31
2013P
2014P
2015P
$235.7
$312.4
$381.1
$110.8
$142.0
$182.6
$0.0
$0.0
$0.0
$9.8
$9.8
$9.8
$34.66
$44.40
$57.10
$391.1
$508.6
$630.6
2011A
$159.9
$68.7
$0.0
$9.8
$25.0
$263.4
2012P
$238.16
$87.46
$0.0
$9.8
$27.35
$362.8
$68.7
$13.9
$62.7
$13.9
$62.7
$13.9
$667.6
($298.4)
$432.9
$835.3
($422.7)
$495.2
$1,133.7
($582.8)
$627.5
$1,477.4 $1,921.3 $2,485.6 $3,197.7 $4,114.5
($800.4) ($1,084.0) ($1,455.9) ($1,942.7) ($2,567.9)
$753.7
$913.8 $1,106.3 $1,331.6 $1,623.2
$6.9
$15.1
$8.7
$685.3
$22.3
$10.8
$10.9
$668.6
$57.1
$9.7
$14.1
$761.6
$60.0
$26.0
$49.6
$1,026.5
$68.7
$26.0
$47.23
$1,258.5
$84.1
$26.0
$47.23
$1,462.3
$100.6
$26.0
$47.23
$1,788.8
$126.6
$26.0
$47.23
$2,162.1
$150.3
$26.0
$47.23
$2,647.7
$67.1
$13.5
$25.2
$2.9
$108.7
$71.4
$16.3
$38.9
$5.9
$132.5
$89.8
$17.1
$46.4
$4.9
$158.2
$111.6
$15.8
$59.8
$1.9
$189.1
$156.0
$14.8
$66.0
$0.9
$237.7
$166.3
$15.5
$71.9
$2.3
$256.1
$201.1
$15.5
$77.3
$1.4
$295.2
$269.2
$15.5
$84.1
$1.4
$370.1
$343.7
$15.5
$90.0
$0.0
$449.2
$427.9
$15.5
$95.5
$0.0
$538.9
$4.4
$23.3
$60.0
$0.0
$0.0
$8.5
$204.9
$3.9
$50.8
$204.8
$13.4
$0.0
$10.2
$415.6
$2.3
$63.3
$52.8
$30.9
$0.0
$11.8
$319.2
$2.9
$69.2
$0.9
$35.2
$14.6
$10.8
$322.7
$3.4
$72.2
$0.0
$68.8
$23.3
$21.5
$427.1
$3.4
$77.2
$2.7
$59.6
$31.8
$25.3
$456.1
$3.4
$82.4
$1.4
$59.6
$40.2
$29.1
$511.3
$3.4
$87.9
$0.0
$59.6
$49.7
$34.0
$604.7
$3.4
$92.5
$0.0
$59.6
$58.3
$38.9
$701.9
$3.4
$97.8
$0.0
$59.6
$63.8
$43.4
$806.9
$0.1
($0.1)
$40.1
$0.5
$56.3
$96.9
$0.1
$0.0
$207.6
($16.0)
$78.0
$269.7
$0.1
$0.0
$251.3
($10.3)
$108.2
$349.4
$0.1
$0.0
$296.6
($12.4)
$154.6
$438.9
$0.1
$0.0
$383.0
($14.7)
$231.0
$599.4
$0.1
$0.0
$470.4
($7.9)
$339.8
$802.4
$0.1
$0.1
$0.1
$0.1
$0.0
$0.0
$0.0
$0.0
$457.2
$487.2
$485.5
$491.2
($7.9)
($7.9)
($7.9)
($7.9)
$501.6
$704.7
$982.5 $1,357.5
$951.0 $1,184.1 $1,460.3 $1,840.9
$301.8
$685.3
$668.6
$761.6
$1,026.5
$1,258.5
$62.7
$13.9
$1,462.3
$62.7
$13.9
$1,788.8
$62.7
$13.9
$2,162.2
2016P
$487.3
$231.5
$0.0
$9.8
$72.40
$801.0
$62.7
$13.9
$2,647.8
29
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 20.
Statement of Cash Flows Projection
Rackspace Hosting, Inc. Statement of Cash Flows Projection
($ in millions, except per share items)
Fiscal Year Ending December 31
Cash Flows from Operating
2007A
2008A
2009A
2010A
Net Income
$17.8
$21.7
$30.1
$46.4
Depreciation and Amortization
$56.5
$90.2
$125.3
$155.9
Loss on Disposal of Equipment, Net
$1.9
$2.9
$1.0
$0.8
Provision for Bad Debts and Customer Credits
$4.1
$4.1
$10.3
$4.3
Deferred Income Taxes
($3.5)
$12.1
$9.4
$6.8
Deferred Rent
$0.4
($0.2)
$4.4
$7.1
Share-based Compensation Expense
$4.3
$15.0
$20.1
$26.6
Other Non-cash Compensation Expense
$0.2
$0.3
$0.0
$0.0
Tax Benefits from Share-based Compensation ($0.6)
($3.2)
$0.0
($2.4)
Changes in Certain Assets and Liabilities
Accounts Receivable
($13.4)
($12.2)
($17.1)
($12.9)
Income Taxes Receivable
$0.0
($12.3)
$4.8
$2.6
Prepaid Expenses and Other Current Assets
$0.0
0
($2.3)
($10.1)
Accounts Payable and Accrued Expenses
$39.2
$13.4
$15.2
$16.8
Deferred Revenue
$6.6
$1.9
($1.2)
($0.5)
All Other Operating Activities
($8.5)
$2.9
($3.3)
$2.9
Cash Flows from Operations
$104.9
$136.6
$196.9
$244.2
Cash Flows from Investing
Purchase of PPE, Net
Acquisitions, Net of Cash Acquired
Earn-out Payments for Acquisitions
All Other Investing Activities
Cash Flows from Investing
2011A
$76.4
$195.4
$0.2
$5.9
$14.0
$9.5
$28.8
$0.0
($20.6)
2012P
$108.8
$254.3
$1.3
$6.1
$16.6
$8.5
$38.57
$0.0
($35.5)
($26.8)
$4.4
($2.6)
$57.5
($0.5)
$1.4
$343.0
($18.8)
$0.0
($2.4)
$15.1
($0.6)
$0.0
$392.0
Fiscal Year Ending December 31
2013P
2014P
2015P
$161.8
$203.1
$277.8
$319.8
$406.8
$521.1
$0.0
$0.0
$0.0
$7.5
$9.4
$11.7
$0.0
$0.0
$0.0
$8.4
$9.5
$8.6
$17.49
$29.55
$22.91
$0.0
$0.0
$0.0
($28.8)
($38.6)
($17.5)
($23.4)
$0.0
($7.3)
$10.7
$0.0
$0.0
$466.3
($31.1)
$0.0
($9.7)
$58.1
$0.0
$0.0
$637.0
($40.6)
$0.0
($12.7)
$47.2
$0.0
$0.0
$818.6
2016P
$375.0
$658.6
$0.0
$15.0
$0.0
$5.5
$28.18
$0.0
($29.6)
($48.9)
$0.0
($15.3)
$57.2
$0.0
$0.0
$1,045.7
($140.4)
($0.3)
$0.0
$0.0
($140.7)
($165.4)
($9.7)
$0.0
$0.0
($175.1)
($117.3)
$0.0
($6.8)
$0.0
($124.1)
($144.8)
($29.9)
($0.5)
($0.1)
($175.2)
($13.9)
($3.9)
$61.1
($5.0)
($0.3)
$0.0
$8.5
$5.0
$0.0
$0.3
$0.6
$52.4
($32.4)
($6.9)
$200.0
($57.3)
($0.2)
$0.0
$1.5
$0.0
$145.4
$2.0
$3.2
$255.4
($44.7)
($6.7)
$0.0
($150.0)
($0.4)
$0.0
$0.0
$0.0
$0.0
$14.5
$0.0
($187.3)
($52.1)
($4.9)
$0.0
($50.0)
$0.0
$0.0
$0.0
$0.0
$0.0
$15.3
$2.4
($89.4)
($65.8)
($1.9)
$0.0
$0.0
($1.1)
($5.3)
$0.0
$0.0
$0.0
$36.3
$20.6
($17.2)
($70.6)
$4.1
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$67.0
$35.5
$36.0
($87.2)
($2.3)
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$35.9
$28.8
($24.8)
($98.2)
($1.4)
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$65.0
$38.6
$4.0
($107.1)
($1.4)
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$53.2
$17.5
($37.8)
($110.7)
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$0.0
$58.4
$29.6
($22.7)
Effect of Exchange Rate Changes
($0.0)
($3.4)
$1.6
($0.1)
($0.3)
$0.0
$0.0
$0.0
$0.0
$0.0
Total Cash Flows
$16.6
$213.5
($113.0)
($20.5)
$54.9
$78.3
($2.4)
$76.7
$68.7
$106.2
$8.4
$24.9
$238.4
$125.4
$104.9
$159.9
$238.2
$235.7
$312.4
$381.1
$24.9
$238.4
$125.4
$104.9
$159.9
$238.2
$235.7
$312.4
$381.1
$487.3
Cash Flows from Financing
Principal Payments of Capital Leases
Principal Payments of Notes Payable
Borrowing on Line of Credit
Payments on Line of Credit
Payments for Debt Issuance Costs
Payments of Earn-out Provisions for Acquisitions
Proceeds from Sale Leaseback Transactions
Receipt of Texas Enterprise Fund Grant
Proceeds from Issuance of Common Stock
Proceeds from Employee Stock Plans
Tax Benefits from Share-based Compensation
Cash Flows from Financing
Beginning Cash Position
Ending Cash Position
($269.8) ($343.73) ($443.85) ($564.35) ($712.09) ($916.79)
($1.0)
($5.95)
$0.00
$0.00
$0.00
$0.00
$0.0
$0.00
$0.00
$0.00
$0.00
$0.00
$0.2
$0.0
$0.0
$0.0
$0.0
$0.0
($270.6) ($349.7) ($443.9) ($564.3) ($712.1) ($916.8)
30
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Appendix 21.
Discounted Cash Flow Analysis
Discounted Cash Flow (DCF) Analysis
Revenue
EBITDA
EBIT
Less: Taxes
Debt-Free Earnings
Less: Purchase of PP&E, Net
Less: Working Capital Requirements
Add: Depreciation and Amortization
Add: Miscellenous Non-cash Items
Total Net Investment
Discount Rate
Net Debt-Free Cash Flows:
Discount Period
Discount Factor @ 11.3%
PV of Net Debt-Free Cash Flows:
$86.54
12.3%
11.8%
11.3%
10.8%
10.8%
12/31/15
12/31/16
$1,548.51 $1,662.4 $2,129.6
$535.8
$575.2
$726.2
$237.9
$255.4
$319.4
83.3
89.4
111.8
$154.6
$166.0
$207.6
(413.5)
(443.9)
(564.3)
6.0
(49.5)
(47.5)
297.9
406.8
521.1
4.3
9.9
25.7
($109.5)
($86.5)
($90.8)
12/31/13
$2,738.8
$955.9
$434.7
152.2
$282.6
(712.1)
(86.2)
658.6
19.1
($139.7)
$45.1
0.93
0.90
$40.8
Terminal TEV / EBITDA Multiple
10.0x
10.5x
11.0x
11.5x
76.44
80.09
83.73
87.37
77.76
81.47
85.18
88.89
79.12
82.89
86.67
90.44
80.50
84.34
88.18
92.02
80.50
84.34
88.18
92.02
12/31/14
$79.5
1.93
0.81
$64.6
12.0x
91.02
92.60
94.21
95.87
95.87
$116.8
2.93
0.73
$85.3
$142.9
3.93
0.66
$93.7
Key Assumptions
Stub Period
Valuation Date
Tax Rate
Discount Rate (WACC)
Terminal Multiple
93.2%
1/25/2013
35%
11.3%
11.0x
Terminal Value Assumptions
Terminal Year EBITDA
Terminal Multiple
Terminal Value
Discount Period
Discount Factor @ 11.3%
PV of Terminal Value
$1,243.2
11.0x
$13,675.4
3.93
0.66
$8,961.8
Implied Analyses
LTM EBITDA Multiple
24.9x
Methods
Weight
Multiple
70%
Precedent Transaction
10%
Discounted Cash Flow
20%
Total
100%
Target Price ($)
90.87
91.18
86.70
90.07
31
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Sensitivity Analysis
Fiscal Year
Implied Potential
2012
2013
2014
2015
2016
Value Increase
Revenue Growth
27.0%
25.7%
27.1%
27.6%
25.8%
82.72
1.05
27.5%
26.2%
27.6%
28.1%
26.3%
84.67
1.07
Base
28.0%
26.7%
28.1%
28.6%
26.8%
86.66
1.10
28.5%
27.2%
28.6%
29.1%
27.3%
88.68
1.12
29.0%
27.7%
29.1%
29.6%
27.8%
90.75
1.15
EBITDA Margin
31.6%
33.6%
33.1%
33.9%
34.8%
84.35
1.07
32.1%
34.1%
33.6%
34.4%
35.3%
85.51
1.08
Base
32.6%
34.6%
34.1%
34.9%
35.8%
86.66
1.10
33.1%
35.1%
34.6%
35.4%
36.3%
87.82
1.11
33.6%
35.6%
35.1%
35.9%
36.8%
88.98
1.13
Tax Rate
34.0%
34.0%
34.0%
34.0%
34.0%
86.56
1.10
34.5%
34.5%
34.5%
34.5%
34.5%
86.61
1.10
Base
35.0%
35.0%
35.0%
35.0%
35.0%
86.66
1.10
35.5%
35.5%
35.5%
35.5%
35.5%
86.72
1.10
36.0%
36.0%
36.0%
36.0%
36.0%
86.77
1.10
CAPEX as % of Revenue
24.2%
24.7%
24.5%
24.0%
24.4%
86.42
1.09
25.2%
25.7%
25.5%
25.0%
25.4%
86.54
1.10
Base
26.2%
26.7%
26.5%
26.0%
26.4%
86.66
1.10
27.2%
27.7%
27.5%
27.0%
27.4%
86.79
1.10
28.2%
28.7%
28.5%
28.0%
28.4%
86.91
1.10
Terminal TEV / EBITDA Multiple
$0.01
10.0x
10.5x
11.0x
11.5x
12.0x
12.3%
76.44
80.09
83.73
87.37
91.02
11.8%
77.76
81.47
85.18
88.89
92.60
11.3%
79.12
82.89
86.67
90.44
94.21
10.8%
80.50
84.34
88.18
92.02
95.87
10.8%
80.50
84.34
88.18
92.02
95.87
Items
Discount Rate
Appendix 22.
$100
$95
$90
$85
$80
$75
Revenue
EBITDA
Margin
Tax
CAPEX % of
Revenue
WACC
Exit
TEV/EBITDA
32
Rackspace Hosting, Inc. (NYSE: Rackspace)
Rackspace Hosting, Inc. (NYSE: Rackspace)
Disclosures:
Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of
this report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as an officer or director:
The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject company’s securities.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the
author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the
basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy
or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society of Texas, CFA Institute or the CFA
Institute Research Challenge with regard to this company’s stock.
CFA Institute Research Challenge
33