It might be pie-in-the-sky thinking that Rackspace Hosting (NYSE: RAX) could overtake Amazon Web Services as king of cloud hosting -- at least not in the near future.

That’s not necessarily a bad thing for investors. While’s (Nasdaq: AMZN) enormous profile has cast a shadow over Rackspace for some time now, being No. 2 in this arena is nothing to sneeze at.

Back in March 2012, my StreetAuthority colleague David Sterman named RAX one of the most overvalued stocks in the market -- but these days, Rackspace is getting some rather special attention at current prices. When Dave's article was published last year, RAX sold for about $54. It subsequently grew even more expensive, to nearly $78 a share this January, but it has since fallen nearly 50% from that high.

Last Monday, RAX's share price of $49.31prompted investors to acquire 21,687 call options on the company, about 815% more than usual. That same day, Rackspace reported third-quarter earnings, showing higher than expected revenue ($389 million, up15.7% from a year ago) but lower than expected earnings per share (EPS), which came in at $0.11 compared with the $0.16 expected.

So, you had some investors selling shares -- price fell by 12% mid-day -- and others betting that the stock would go up. Here a few possible reasons for the dichotomy.

Rackspace's earnings miss was due in part to the company's bigger than expected investments on new Performance Cloud Servers, a move being applauded by its critics and one that differentiates itself from Amazon. Without getting too technical, the servers use Intel's (Nasdaq: INTC) Xeon E5 processors with 120 GB of RAM, meaning they’re faster, more reliable and less prone to failure.

According to IT research firm IDC, “Everyone is gunning for (Amazon Web Services) right now, and performance is one area where competing public clouds feel they can differentiate from them.”

Another factor in Rackspace's miss on earnings might be the nearly 4,800 physical servers it added in the second quarter, which marked a significant increased from the previous two quarters and brought its total number to just shy of 99,000.

After being criticized for the slow pace of growth in its cloud computing business, this was welcome news for investors. The reason for all the new servers: a deployment of new cloud infrastructure in Virginia, Australia and Hong Kong that required added capacity -- which, by the way, is all due to be upgraded soon with Xeon E5 processors.

Unfortunately, Rackspace has been caught between a rock and a hard place. On one hand, as new business churns out revenue, the $5.9 billion company also requires more servers and additional capital expenditures. As a result, second-quarter investments totaled $119.8 million, compared with $188 million for the previous two quarters combined.

“We’ve increased our investment levels to play for a bigger long-term outcome," CEO Lanham Napier says. "This is how we see things right now. We think now is the time to really go for it.”
Some analysts and the financial media think so too.

• Fortune magazine, citing Warren Buffett's famed advice “to be fearful when others are greedy, and be greedy when others are fearful,” reported that RAX is now considered oversold according to its relative strength index reading.

• JMP Securities concluded Rackspace made a worthwhile investment in the new servers and expects the company to grow 20% in 2014 with a target price of $67.

• Oppenheimer reiterated a buy rating on RAX with a $62 price target.

On the other hand, analysts at Evercore Partners cut their number from $56 to $52.50.

Risks to Consider: With a 52-week low of $34, RAX may have more room to fall in the short term, especially after an earnings miss. There's also the obvious risk that Rackspace's capital investments might not pan out as expected.

Actions to Take --> Much like Amazon, Rackspace is a great long-term investment. I wouldn’t be actively trading RAX; I would use the 200-day moving average -- which currently stands at just under $45 -- as a buy trigger.

Related Articles
  1. Economics

    The Biggest Oil Producers in Latin America

    Find out which countries produce the most oil in Latin America, and learn about some of the biggest oil companies operating in each country.
  2. Stock Analysis

    The 6 Biggest Russian Energy Companies

    Learn about the top energy companies in Russia, a country that holds some of the largest reserves of oil, natural gas and coal in the world.
  3. Stock Analysis

    The Biggest Oil Producers in Asia

    Learn which Asian countries deliver the most crude oil to market, and discover what companies are the biggest producers in each country.
  4. Stock Analysis

    The 5 Biggest Russian Oil Companies

    Discover the top Russian oil companies by production volume and find out more about their domestic and international business operations.
  5. Insurance

    The 5 Biggest Russian Insurance Companies

    Discover the five companies that dominate the Russian insurance market, and learn a little more about their business operations and ownership.
  6. Insurance

    Biggest Life Insurance Companies in the US

    Read about the top life insurance companies in the United States as measured by written premiums and learn a little more about their business operations.
  7. Stock Analysis

    The 7 Biggest Chinese Mining Companies

    Read about the seven largest Chinese mining companies as measured by revenues, and learn more about the types of mineral resources they mine.
  8. Stock Analysis

    The 6 Biggest Life Insurance Companies in Canada

    Read about the biggest life insurance companies in Canada, and learn about their business operations and the types of products they offer.
  9. Stock Analysis

    The 7 Biggest Canadian Natural Gas Companies

    Read about the seven biggest Canadian natural gas companies as measured by production volume and learn a little more about their recent performance.
  10. Stock Analysis

    The 6 Biggest Chinese Energy Companies

    Read about the six companies atop the Chinese energy industry as measured by consolidated revenue, and learn more about their energy operations.
  1. What is the long-term outlook of the metals and mining sector?

    An industry agency council was established by the World Economic Forum in 2014 to serve as an advisory board on the future ... Read Full Answer >>
  2. What is the railroads sector?

    The railroads sector is comprised of publicly traded stocks for companies that operate railroad tracks and/or trains. Railroad ... Read Full Answer >>
  3. Who are Amgen Inc.'s (AMGN) main competitors?

    Biotech giant Amgen Inc (AMGN) bills itself as one of the first biotechnology firms. It was founded in 1980 and has grown ... Read Full Answer >>
  4. What's the most expensive stock of all time?

    Back in late August 2012, Apple’s (AAPL) stock price reached nearly $700 per share. The stock has since split but has yet ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!