This document provides an analysis of Rackspace Hosting, Inc. (RAX), a provider of managed cloud services. It discusses RAX's business operations, financial performance, partnerships, competitive positioning, and growth opportunities in the expanding cloud computing market. The analysis recommends a "Buy" rating for RAX stock based on its leadership in managed cloud services and ability to capitalize on growing enterprise adoption of cloud platforms.
4. RAX has assembled a board of 9 directors, selected via voting at shareholders’ annual meetings, with 4
established committees: Nominating and Governance, Audit, Real Estate and Finance, and
Compensation. The Board is structured as classified, limiting directors’ accountability due to their 3-year
term election but encouraging a longer timeframe, desired for technology companies. Despite this
structure only two members, non-executive, have been onboard for more than 5 years. Moreover, the
company has set forth stock ownership requirements for all executives of at least 3x base salary to
encourage commitment to shareholder value creation. As of Jan 15, all directors and executives held a
combined 14.1% ownership on RAX (Table 2), a number largely skewed by founder Graham Weston
stake of 14.1%. Remuneration for the CEO and Executive team is structured using a “Say on Pay”
methodology with support from independent consultant Compensia Inc., leader in compensation
consultancy serving over 27% of the market for IT companies. In 2014, RAX’s performance-based
compensation for CEO and continuing named executive officers accounted for 44% and 34%
respectively of their total remuneration package, with the majority of the compensation vested over
multi-year periods – 87% and 72% respectively – aligning executives with the long-term interests of
shareholders. At the last annual meeting, compensation was approved with more than 87% of votes
“FOR”, which signals strong acceptance by the shareholders. Further details in APPENDIX 14.
RAX’s employee-led people-centric initiatives, such as Rack Gives Back and its fund, The RackSpace
Foundation, are aimed at elevating and further developing RAX’s surrounding communities through
volunteerism, grants and education. Additionally, RAX supports sustainability within the cloud industry
through its RackSpace Startup Program and The RackSpace Cloud University. Moreover, to ensure
environmentally conscious operations, RAX has committed to the goal of powering worldwide
operations with renewable energy and thus has been recognized through its listing on the Dow Jones
Sustainability Index and the FTSE4Good Index. Further details on social responsibility programs are
presented in APPENDIX 4.
- Enterprise IT investment is proportional to the state of the economy, thus strong
macroeconomic indicators represent a positive outlook for cloud computing as part of organizations’ IT
budgets. GDP as a measure of economic health paints an optimistic picture for upcoming years.
Estimated annual growth in the US comes north of 2.7% yearly until 2018 when it starts slightly dropping
but staying above 2.0% through 2020. Similarly, the EU is expected to come out of the lengthy period of
economic difficulty to present steady growth of 1.9% up to 2020, with UK as one of the leading factors
growing 2.2% a year3 (Figure 5).
. Cloud computing is
meaningfully responsible for the utter disruption of traditional business models’ practices. The cloud’s
elastic scalability (shift to Pay-as-you-go versus install-and-own), cost savings and resource
optimization is making it the fundamental IT engine for business customers. At a global level, cloud
computing is expected to grow at a remarkable rate of approximately 43.37% CAGR reaching $132B in
2020 (Figure 6)4. It is estimated that 11% of IT budget will shift away from in-house towards one or more
versions of cloud computing. Accordingly, spending on Infrastructure as a Service (IaaS) and Platform as
a Service (Paas) is expected to grow at a 30% CAGR (2013-2018) as opposed to 5% growth for overall
enterprise IT spending. Similarly, by 2018, over 60% of companies will have at least half of their
infrastructure on cloud-based platforms5
Customers today expect simple real-
time interactions anytime, anywhere through increasingly interconnected devices. By 2020, it is
estimated that 4B people and 31B devices will be connected to the Internet6, generating a tremendous
influx of unpredictable data. These trends require enterprises to rethink the way they are currently
delivering their business by migrating from rigid on-premise environments to dynamic and scalable
networks able to quickly address consumers’ needs. This can only be attained by the cloud, which
provides elastic on-demand provisioning of IT resources. Consequently, as supported by the survey
results in Figure 7, there is a shift within companies’ IT investment priorities by reallocating financial
resources to more strategic opportunities for businesses’ digital transformation. On average, more than
60% of IT organizations are increasing operational IT budgets for 2016 while IT CapEx remains relatively
unchanged (Figure 8). This tendency of lowering IT spending as a percentage of increasing revenues is
mainly explained by the steady stream of companies migrating to the cloud and thus lagging behind in
IT employee headcount.
– Cloud computing is on the verge of major growth in the
public sector. Many government organizations have been historically cautious about cloud adoption
due to privacy and security concerns but today governments worldwide are supporting cloud-related
standards development (e.g., US, EU), investing to create economic regions of cloud technology (e.g.,
China, Japan) or migrating their own IT infrastructures to cloud services (e.g., US, UK, Japan) 8. By 2018,
the global government cloud market will be worth $18.5B (45% CAGR from $2.78B in 2013)9 accounting
for more than half of global software, server and storage spending growth 10. In 2013 the CIA awarded a
$600M private cloud contract to AWS, a milestone for this transition.
10. Information security is a major concern for customers
switching to the cloud with 38% of IT managers surveyed in North Bridge’s 2015 “Future of Cloud”
study, putting it as the top challenge to their migration. Of those currently using the cloud, 85% are
confident in their cloud vendor’s ability to provide a secure environment as opposed to 90% of IT
managers who lack confidence in their companies’ ability to detect problems internally, which
signals strong confidence in cloud security. Regardless, RAX could be exposed to breaches and
interruptions that could lead to reputational effects, revenue loss and lawsuits. In order to mitigate
this risk, the company has put together a team of security professionals and infrastructure to secure
their datacenters from internal and external threats, becoming compliant with top industry
standards such as ISO/IEC 27001:2005 Information Security Management System (ISMS) Standard,
ISAE 3402 / SSAE 16 Type II SOC 1 and Payment Card Industry Data Security Standard..
Alterations to electronic data protection laws could
allow governments, in countries where cloud computing companies host their data centers, access
to information stored by business customers even if they are not based on that country. Likewise,
laws and regulations could be passed by client-side governments to limit the ability of companies to
either send data overseas or outsource processes like information security to other countries in
order to ensure data privacy according to national laws. This could slowdown cloud adoption as
companies would try to prevent their data from being accessed and exposed by foreign
governments.
Service outages or any interruptions that cause
downtime will affect RAX’s customers directly. Frequent interruptions may cause clients to have
reservations about RAX’s reliability and switch to other managed service providers. Additionally, as
part of RAX’s Service Level Agreement (SLA), uptime for their services must be at least 99.99% or
they may incur in penalties of up to 10% of revenues for each hour of downtime which would
represent approximately $228,325 of revenue lost per hour down based on 2016 data. RAX mitigates
this risk by designing datacenters with redundancies and constantly backing up data with replication
among their 13 datacenters, which translated to a total stoppage of just 7.52 hours during 2014
(Figure 23). For 2016, in case total downtime exceeds 262 hours, loss of revenues and penalty fees
would change our recommendation to a HOLD..
Unmanaged cloud providers could integrate
forward and enter the space to compete directly with RAX, leveraging an already extensive global
network of professionals and clients. We believe this is unlikely to take place any time soon as
AMZN, GOOG and MSFT have focused their strategy on their core business, outsourcing managed
cloud services to hundreds of different providers to deliver this added value to their clients. Other
sources of competition include startups that offer managed services through partnerships with big
IaaS providers, which may allow them to gain important market share in the managed cloud
segment becoming direct competitors for RAX. Our recommendation would change to a HOLD if
RAX’s share of managed cloud services atop unmanaged cloud providers does not reach at least
6.25%.
The further development of SaaS as the predominant
business model for cloud services could reduce workload processing needs for RAX's customers
due to centralization of infrastructure in the SaaS provider. With most new software being built for
cloud from the outset, it is predicted that by 2016 over a quarter of all applications (approximately
48M) will be running atop the cloud. Worldwide SaaS market is expected to grow at an astounding
20.2% CAGR from $18.2B in 2012 to $45.6B in 201725.
Increase in the availability of cheap skilled
labor could render RAX’s managed cloud services less attractive by lowering in-house cloud
management costs for businesses. A potential catalyst of higher skilled labor availability might be
changes in migration laws that could potentially generate an accelerated influx of IT professionals,
especially from India, lowering IT personnel hiring costs to the point where RAX’s service offerings
no longer makes sense financially. Currently, Visas like the H-1B allow companies to employ foreign
workforce for lower salaries which received support from some congressmen that intend to enact a
bill to triple the amount of such visas being issued. In the industry, the costs savings of hiring an H-
1B over an American are approximately 43%.
.
“SOURCE:TEAM ANALYSIS
11. Accelerated disruptive innovations could lead to “autonomic
computing” of most of the tasks offered by managed cloud providers, rendering RAX’s services
unnecessary for most companies. Startups like CloudHealth Technologies have been working on
platforms to perform IT cloud service management through automated governance rules or
artificial intelligence instead of manual processes. This technology is still in early stages of
development and might take years for full commercial use. Additionally, disruptive technologies,
especially enterprise oriented innovations, tend to hit mainstream status after 3-5 years in the
market, so we wouldn’t expect any new technology to affect RAX business at least until 2021,
when cloud autonomics’ impact could change our recommendation to a HOLD if Fanatical Support
for Third Party Clouds projected revenues were cut by 80%.
Over 30% of RAX’s revenue is generated in foreign
currency, especially GBP. Strengthening of the US Dollar against other currencies could lead to a
reduction in revenues from foreign subsidiaries.
Serious economic slowdown, especially in the US and UK
where most of RAX’s revenues are generated, could impact its sales growth as IT has historically
been an early budget-cut casualty in most recessions when companies are expecting lower or
inexistent progress. Economists at reputable investment firms put the chances of a recession
within the next 5 years above 50% (Table 11). Even though it is rare for economists to accurately
forecast a recession, in the US they occur every 5 years on average. Additionally the Chauvet
Model (“An Econometric Characterization of Business Cycles with Factor Structure and Markov
switching") to calculate the probability of a recession sits close to 25%, up from 5% last year. We
don’t expect RAX to be significantly affected by slight contraction in GDP since back in 2008 and
2009 they managed to grow revenues by 46% and 18% respectively despite the deepest recession
in more than 70 years. However if revenue growth were to fall below xx% due to systemic
slowdown, our recommendation would change from a BUY to a HOLD.
As part of our growth projections, we expect RAX to take on
more debt in the medium term to finance growth. The Federal Reserve increased the interest rate
a quarter of a percentage point on December 2015 and Janet Yellen suggested more increases in
the future. These raises will likely increase interest expenses for the company in future debt
transactions, impacting the bottom line. Should conditions result in RAX having a cost of debt
above the 13.03% mark, it would change our recommendation from a BUY to a HOLD.
“SOURCE:FIRMS’WEBSITES
26. As part of management decision making process before undertaking projects, an Economic Value Added (EVA) analysis must be
conducted. This, in order to assess if economic profit added through the years has been in line with shareholders’ required returns.
RAX’s CFO Karl Pichler is an alumni of Stern Stewart, who developed the methodology.
780.6 1,025.1 1,309.2 1,534.8 1,794.4 2,000.1
79.6 123.5 172.7 133.1 167.5 189.6
(27.9) (42.4) (64.3) (44.8) (51.5) (63.5)
51.7 81.0 108.4 88.3 116.1 126.1
497.4 609.4 698.5 872.0 1,031.1 1,203.1
9.4% 9.4% 9.4% 9.4% 9.4% 9.4%
5.1 24.0 43.0 6.7 19.6 13.5
$400,000 $790,361 $1,749,878 $2,940,239
$3,071,372 $2,636,855 $12,721,045 $18,429,272
$3,471,372 $3,427,216 $14,470,923 $21,369,511
$400,000 $367,515 $0.00 $767,515
$2,180,038 $1,567,167 $6,314,752 $10,061,957
$2,580,038 $1,934,682 $6,314,752 $10,829,472
$566,519 $536,418 $11,399,910 $12,502,847
$1,645,281 $2,060,984 $7,825,850 $11,532,115
$2,211,800 $2,597,402 $19,225,760 $24,034,962
27. In order to assess RAX’s Corporate Governance, its strength and weaknesses, we resorted to the Institutional Shareholder Services
(ISS) Rating Methodology. This scoring tool was applied in order to identify and assess risks within RAX’s Corporate Governance
structure.
10 Insignificant threat to Shareholders
8 Low threat to Shareholders
6 Moderate threat to Shareholders
4 Significant threat to Shareholders
2 High Threat to Shareholders
8/10 20% 0.16
8/10 35% 0.28
6/10 20% 0.12
7/10 25% 0.18
7.35/10 100% 73.50
Company maintains independence guidelines set forth by SEC and NYSE. An
example of this is Mr. Weston, former Chief Executive Officer, who was an
employee of the Company prior to 2015 and is therefore not “independent,” so the
Board of Directors has appointed Michael Sam Gilliland as its lead independent
director, or “Lead Director”, to preside at all executive sessions of “non-employee”
directors, as defined under the rules of theNYSE.
In the last year board and CEO compensation growth has far outpaced stock
price growth. The board maintains this compensation package was designed to
retain executivetalent.
Graham Weston, member of the Real Estate & Finance committee. RAX has leased
office space to Santa Clara Land Company, Ltd, of which Graham Weston is a
minority partner. Mr. Weston’s interest in this transaction would be approximately
$84,732.53. Audit Committe believes the terms of this transaction are no less
favorable to the company than could have been obtained from unaffiliated third
parties.
28. Company maintains independence guidelines set forth by SEC and NYSE. An
example of this is Mr. Weston, former Chief Executive Officer, who was an
employee of the Company prior to 2015 and is therefore not “independent,” so the
Board of Directors has appointed Michael Sam Gilliland as its lead independent
director, or “Lead Director”, to preside at all executive sessions of “non-employee”
directors, as defined under the rules of theNYSE.
In the last year board and CEO compensation growth has far outpaced stock
price growth. The board maintains this compensation package was designed to
retain executivetalent.
Graham Weston, member of the Real Estate & Finance committee. RAX has leased
office space to Santa Clara Land Company, Ltd, of which Graham Weston is a
minority partner. Mr. Weston’s interest in this transaction would be approximately
$84,732.53. Audit Committe believes the terms of this transaction are no less
favorable to the company than could have been obtained from unaffiliated third
parties.
We deem this favorable. CEO does not serve on other boards. 3 members sit on
0 boards. 3 members sit on 1 board. 1 sits on 2 boards. 1 sits on 3 boards. The
only director who sits on excessive boards is 1 who sits on 8 boards
Non Audit fees represent 0% of total fees. No member of Audit Committe may sit
on more than 3 other boards. Two financial experts sit on this committee, one CPA
and one MBA.
Classified board. Board has power to emit blank check preferred stock. No poison
pill.
Founder is chairman of the board. CEO and Executive compensation plan is
performance based. Company requires 3x salary worth of stock ownership.
Company ranks third highest among its peers in insider ownership with a 14.79%
insider ownership.
RAX uses Say-on-Pay and lets shareholders vote on compensation packages.
There is no unequal voting structure, all classes of stock can vote for all directors.
The board is scheduled to hold its regular meetings at least once a quarter, at least
one additional time per year to review and approve yearly goals and operating
plans. In practice the board of directors held 19 meetings during the year ended
December 31, 2014. Each director attended at least 75% of the aggregate of the
meetings of the Board of Directors and of the committees on which he or she
served during the period for which he or she was a director or committee member,
respectively.
They can serve three years, but can stand for reelection. Although the company
lacks formal term limits, approximately nine to twelve years of service is an
expected commitment for any individual director. For example, Mr. Mellin and Mr.
Bishkin, consistent with the Company’s guiding principles for Board development
and succession, have declined to stand for re-election in 2015 and will not be
directors following the annual meeting.
29. RAX strives to support Self-funded
startups and entrepreneurs affiliated with
Accelerators, Incubators, Universities and
Venture Capital Firms. Through this
program, qualified startups can benefit
from up to $2,000 per month in free
hosting for a year as well as RAX’s
Fanatical Support® and expertise to
accompany them in building applications
and scaling on the cloud.
CloudU™ is a cloud curriculum for IT
professionals looking to reinforce their
knowledge of Cloud Computing. The
program, designed through a
collaboration between RAX and
industry analysts, offers access to a
comprehensive database of
educational resources aimed at
increasing cloud computing knowledge
among businesses. Given its vendor-
neutral nature, CloudU™ is open for
anyone who is interested on cloud
adoption, regardless of vendor or
platform.
RAX’s global initiative focuses on three pillars:
People, Planet and Pocket.
• People: The core of RAX’s social responsibility
programs resides on its service culture and
thus on the Rackers who volunteer to be part
of the environmental solution and give
Fanatical Support to the communities in which
the company operates.
• Planet: As part of its decision-making, RAX
integrates both energy conservation &
efficiency into for building, buying and
operating.
• - Pocket: Finding the best sustainable choices
which are also financially efficient and
effective by empowering customers, through
corporate responsibility and maximizing
stockholder and customer long-term value.
Being an employee-led volunteer force,
the program supports the community by
focusing on three main areas: offering
grants aimed at arts and culture in order
to establish a creative class of citizens;
education, specifically related to STEM;
and technology. Rack Gives Back
includes employee volunteerism,
corporate funding and grants and The
Rackspace Foundation.
Founded in 2009, The Rackspace
Foundation functions as a public charity
that focuses on elevating the community
on RAX’s headquarters’ surrounding
neighborhood. Primarily funded through
payroll contributions, The Foundation
invests on non-profits that work in school
and afterschool based programs.
30. As cloud computing becomes increasingly mainstream, the challenges faced by enterprises for adopting these technologies
account for the rapid growth of the managed cloud market. Since this segment is expected to have strong long-term revenues, it is
highly attractive for new competitors with regulation in the sector still in its early stages, presenting low or no entry barriers for new
players. Given the company’s nature of being capital intensive, high sunk costs are incurred when setting up the infrastructure. New
entrants could work around that and partner with unmanaged cloud giants to offer their services on top of their infrastructure and
thus benefit from their economies of scale, stablished customer base and growth in the industry. However, these companies are
wary of their reputation and partnerships require a solid track record. Furthermore, economies of expertise are a solid barrier to
entry, given the low availability of skilled labor. These conditions somewhat limit the entrance of new players, hence we assess this
as a MODERATE threat for the business.
Electricity providers are one of the most important suppliers of the business in terms of cost of revenue, but as a heavily regulated
industry with commoditized prices, there is low threat of electricity suppliers exercising bargaining. Other important suppliers
include hardware and connectivity, both of which are commoditized and not concentrated, none of these are monopolistic
industries and switching costs are relatively low. Moreover, RAX’s service centric business model puts a lot of weight on talent as a
“supplier”. Even though there is a shortage of qualified personnel, none of RAX’s 6,000+ employees are represented by a collective
bargaining agreement. We assess the bargaining power of suppliers as posing a LOW threat to the business given the stated
analysis.
There is a HIGH threat of substitute products as customers of managed cloud services might see more added value in other options
such as handling computing in-house in their own datacenters which provides flexibility and oftentimes lower lead times;
Outsourcing their IT infrastructure to a service provider, ensuring standardization and usually qualified professionals; Opt for the
unmanaged cloud services which provides the cheapest option and higher level of flexibility. The impact of this threat depends on
the cost of specialized IT staff and infrastructure engineer and the level of flexibility required by companies as technology becomes
a more integral part of business, often requiring lower lead times. The different options available to businesses to fulfill their IT
needs leads us to assess the threat of substitute products as HIGH.
As stated, RAX’s customer base is solid (average monthly churn of 0.6% for 2014) and well diversified (300,000+ customers) with no
single client representing more than 2% of revenues. Even though there are many providers in the segment, customers face high
switching costs when trying to change from one vendor to another due to proprietary technologies, the industry’s lack of common
protocols and standards, and the service provider’s experience and understanding of the customer’s technology backbone. Given
RAX’s diversified customer base and the limitations for switching cloud service providers, we assess the bargaining power of
customers as MODERATE.
We assess the competitive rivalry within the managed cloud segment as being MODERATE due to its high fragmentation, having a
broad set of players with multiple delivery models. Competition is increasingly becoming more intense as the segment continues to
grow and develop. Given that revenues for the segment are driven by the added value offered by vendors, said competition
focuses on service differentiation as opposed to price cuts. Incentives to fight are present despite the stellar industry growth thanks
primarily to the vast economies of scale that characterizes the cloud..
31. Gartner’s Magic Quadrant positions technology players within a specific market. The assessment presents a broad view of the
relative positions of the market's competitors, how well technology vendors are executing their stated visions and how they are
performing against Gartner's market view. This assessment results in the positioning of the market players within four quadrants:
Leaders - Have proved a powerful market position and technical competence, constantly innovate on current product offering, and
have a reliable service for corporate-class needs being able to cater to a wide variety of customers by addressing a wide set of use
cases with stand-alone or integrated solutions.
Challengers - Have are known for delivering good service capabilities, nonetheless are trailing the market's evolution. Challengers
are usually companies with sound legacy managed hosting services but have not exploited technology and market demand to
develop cloud-enabled hosting services.
Visionaries – Disruptive approach to the market mostly comprised of new, and limited, service portfolios. Visionaries have an early-
mover advantage as well as roadmaps that may take them to a Leader position in the future.
Niche Players – Either emerging vendors or specialists with a focused product portfolio serving a specific use case with a higher
level than generalized vendors.
32. In accordance to RAX’s business model, Gartner positions the company within its Magic Quadrant for Cloud-Enabled Managed Hosting
along with other leading players both in North America and Europe. Nonetheless, even though RAX’s value proposition focuses in
delivering over the top customer experience through its broad portfolio offering of managed cloud solutions, its Managed Hosting is
still compared against unmanaged cloud giants such as AWS and Azure.
According to Gartner’s Magic Quadrant for Cloud Infrastructure as a Service, the following vendors compete within this market:
Amazon AWS - ranked as the highest IaaS provider in both ability to execute and holistic vision, AWS has 10 times the compute
capacity utilization level of all other 14 providers in the IaaS Magic Quadrant combined. AWS is regarded as innovative and agile,
serving the broadest range of use cases. The technology is reinforced by a wide network of partners that provide various IT
professional services.
Microsoft Azure – Currently Microsoft compute capacity utilization is twice as much than the 13 other providers in the IaaS Magic
Quadrant. With Azure, Microsoft is developing an aggressive roadmap of new features and differentiated capabilities. Nonetheless, it’s
still missing key security, flexibility and availability features.
IBM SoftLayer – has a broad portfolio comprised of public, private and managed cloud products. Its strength resides on its product and
service interoperability, as well as its consulting and outsourcing capabilities.
Google Cloud Engine – Initiated only in 2012, has achieved an extensive experience with cloud-native application development and
management. Cloud Engine is considered to offer an excellent value and prompt provisioning, being differentiated by platform and
manageability features as opposed to price. However, Google is on the early stages of developing engagement with enterprise and
midmarket customers, and still has a nascent partner program.
VMware vCloud Air – focused on driving adoption by leveraging its already built influence in on-premise data centers and thus offering
a coherent experience across VMware-based infrastructure.
True to RAX’s focus on a customer centric service offering, it delivers a holistic portfolio of IT solutions based on added value for its
business clients. As opposed to the unmanaged cloud providers, a more diverse and integrated service offering through diverse cloud
form factors based on open source standards.
According to Gartner’s Magic Quadrant for Cloud-Enabled Managed Hosting, the following vendors compete within the same “Leaders”
quadrant as RAX:
Datapipe: midsize hosting and cloud IaaS provider operating data centers in 7 locations in North America, and also has facilities in
Europe and Asia-Pac. Datapipe has truly integrated its hosting and cloud IaaS capabilities with AWS and Azure.
BT Global Services: Europe based provider of managed network, communications and IT services, focused on vertical industry
solutions. Through its Cloud Management System offers business and bundling capabilities.
Interoute – offers a comprehensive portfolio of networking colocation, hosting and cloud services, showing an structured offering from
completely self-service to fully managed products. With data centers stablished across major European countries, Interoute is
currently expanding to North America.
Claranet – As managed hosting provider with a Pan-European presence, Claranet offers colocation, hosting, network and application
services, including hybrid solutions through its partnership with AWS. The provider offers regionalized business services, thus offering
solutions for data sovereignty and technical support. Claranet provides a different service approach for each country, resulting into an
inhomogeneous solution portfolio.
Colt - international network and provider of colocation and hosting services in Europe, U.S. and Asia. Due to its strong Pan-European
presence, Colt is ahead of customers’ data sovereignty needs. The company heavily focuses on partnerships with large vendors
making it subject to their roadmaps.
IaaS Market Key Players Comparison
Dedicated
Hosting
a a
Public Cloud a a a a a a
Private Cloud a a a a
Hybrid Cloud a a a
Customer
Support
a a
Platform
OpenStack Proprietary Proprietary Proprietary Proprietary Proprietary
SLA Level 100% 99.99% 99.95% 100% 99.95% 99.95%
SLA Credit
Unmanaged: 5% /
hour
Managed: 10% / hour
10% of annual
bill
<99.9% - 10%
<99% - 25% 10% - 50%
33. AMZN has established a global partner tiered program, AWS Partner Network (APN), comprised of Consulting and Technology
Partners, who advance through various stages based on engagement with AWS. Through its Premier Consulting Partner tier,
AWS highlights the top global APN Consulting partners with extensive experience in deploying customer solutions on AWS,
have a strong bench of trained and certified technical consultants, have at least one APN Competency, have expertise in project
management, and have a healthy revenue-generating consulting business on AWS. Click here to learn more about becoming a
Premier Partner.
Considering the significant dependency of our DCF model in RAX’s ability to capture future market share from the manages
services provided atop AWS, we regard as necessary conducting a thorough assessment of RAX’s direct competitors as a new
AWS Premier Consulting Partner.
2nd Watch: AWS Premier Partner providing managed cloud to enterprises and helps automate the development, deployment,
governance, procurement, financial management, migration and operations of over 400 enterprise workloads and
approximately 75,000 instances in its managed cloud.
Apps Associates LLC: is a global provider of business and IT consulting services. They help clients adapt and grow in a changing
world of technology by focusing on innovation, process, workforce development and re-usable solutions.
Aquilent – is a recognized leading provider solutions for federal customers with an emphasis on cloud computing, mobile and
digital strategy, web content management, user experience and portal & application development.
ClearScale – has the proven capability to build, deploy, automate and manage cloud architectures on AWS. Their core
competency is delivering custom cloud projects and services for clients who have limited cloud expertise on staff or who need
additional resources to execute better and faster. Based in San Francisco Area.
Cloudnexa – deploys and manages cloud infrastructure for AWS clients. Their cloud management as-a-service from with no
upfront fees or long-term contracts, architecture and migration services included.
Cloud Technology Partners – is an innovative cloud consulting and professional services firm serving mid-market, enterprise
customers and software providers. Its consulting expertise includes migrating applications and data to the platform, developing
cloud-native applications on AWS, and architecting, building and managing AWS deployments.
Corpinfo – A leading technology firm providing Cloud Consulting Services, Infrastructure Solutions, and Managed Services. They
use their experience to ensure that clients have the best technical solutions to solve their business challenges and deliver value
for their organization.
CSC - CSC leads clients on their digital transformation journey, providing innovative next-generation technology solutions and
services that leverage deep industry expertise, global scale, technology independence and an extensive partner community.
Logicworks – is an enterprise cloud automation and managed service provider that combines advanced automation and
DevOps capabilities with 22+ years of legacy IT experience.
Mobiquity - is a mobile computing professional services firm helping clients design, develop and deploy custom mobile
solutions.
Pariveda Solutions Inc: is a leading management consulting firm specializing in improving their clients’ performance. Provide
strategic consulting services and custom application development solutions for mobility, cloud computing, data, portals and
collaboration, CRM, custom software, enterprise integration and user experience needs of their clients.
REAN Cloud – A cloud-native firm with experience supporting enterprise IT infrastructures and applications. Their key
differentiator is their experience in implementing complex and scalable architectures, which support secure, compliant
operations in highly regulated industries such as the Financial Services, Healthcare/Life Sciences, Education, and Public Sector
verticals.
Smartronix - is a global professional solutions provider specializing in cloud computing, application integration and
development, software and hardware engineering, networking and system management, and cyber security.
TriNimbus: Leading DevOps service provider with DevOps and Big Data Competencies. The team focuses exclusively on AWS
and its surrounding ecosystem to support customers who are using the cloud to elevate their culture, environment and
operations to the next level.
Wipro – leading Information Technology, Consulting and Outsourcing company, that delivers business outcomes through its
industry experience and a 360 degree view of 'Business through Technology' – helping clients create successful and adaptive
businesses.
34. In order to evaluate internal and external factors that influence RAX’s current strategic situation, a SWOT Analysis was prepared
that describes positive attributes, tangible and intangible, that allow RAX to differentiate from competitors; characteristics of RAX
that detract from the value offered or places the firm at a competitive disadvantage; reasons RAX is likely to thrive and issues
beyond the company’s control that could put the business at risk.
35. We assessed the importance of each factor to RAX as graphed in the Y axis for strengths and weaknesses. In regards to the
opportunities and threats our Y axis shows the probability of becoming materialized.
Through the SWOT Analysis graphs we concluded that RAX's most relevant weakness is how it is pricier than other managed
cloud solutions. Nonetheless, this is directly related to RAX’s highly specialized workforce, a key strength, a main differentiation
that can allow them to capitalize on the opportunity of operating within a rapidly growing industry. We have identified as a the
likeliest threat the development of new technologies that reduce engineering complexity such as Open Compute Project, Open
Network Linux, Dockers and containerization.
36. In order to assess and understand RAX’s financial results and thus verify its earnings quality, we used the Beneish M-Score Analysis
(1999) for earnings manipulation detection. The M-Score is comprised of eight different variables that identify either financial
statement distortions or indicate a firm’s likelihood of earnings manipulation: DSRI = Days’ Sales in Receivables Index
• GMI = Gross Margin Index
• AQI = Asset Quality Index
• SGI = Sales Growth Index
• DEPI = Depreciation Index
• SGAI = Sales, General and Administrative expenses Index
• LVGI = Leverage Index
• TATA = Total Accruals to Total Assets
The M-Score can be calculated considering 8 or 5 indices as follows:
• 5-variable Model: M = -6.065+ .823 DSRI + .906 GMI + .593 AQI + .717 SGI + .107 DEPI
• 8-variable Model: M = -4.84 + .920 DSRI + .528 GMI + .404 AQI + .892 SGI + .115 DEPI -.172 SGAI + 4.679 Accrual to TA - .327
Leverage
M-Score lower than -2.22 – The firm is not likely to be a manipulator.
M-Score greater than -2.22 – The firm is likely to be a manipulator.
Based on the M-Score Analysis conducted, RAX is not likely to be manipulating its earnings results.
37.
38. Below we present the rationale behind our main assumptions. Our revenue assumptions are detailed as part of the written
report.
Beta – In order to assess RAX’s level of systemic risk, we calculated a Beta by regressing its historical monthly returns from
January 2011 to December 2015 against each of the following indices: S&P 500, NASDAQ and Russell 1000.
Our calculations revealed that the NASDAQ has a stronger correlation with RAX based on the resulting R-Squared of 0.25,
meaning that 25% of variation in returns can be explained by that of said index. Moreover, said regression resulted on a P-
Value of 0.01%, the smaller the value the stronger the evidence that observations are significant in predicting RAX’s returns.
On the other hand, the S&P500 resulted on a weaker R-Squared of 0.2% and P-Value of 0.02%. Nonetheless, in order to be
conservative, we used the S&P500 due to its higher value for Beta.
Cost of Debt - At the valuation date, the market value of RAX’s debt was $451.9M with a yield of 8.04% (average yield of
7.0%). For the computation of RAX’s Cost of Capital we assumed the current yield to be its Cost of Debt.
Debt/Capital – We expect RAX’s current Debt / Capital ratio of 22.7% to move towards that of its peers (48.6%). Therefore,
we assumed a target ratio of 30% throughout the forecasted period.
Cost of Revenue – RAX’s Cost of Revenue is mainly comprised of fixed items such as employee-related expenses and data
center operation costs. In addition, RAX incurs in variable costs including, but not limited to, power and bandwidth. For the
purposes of our 10-year projection, we analyzed the historical behavior of this cost item as a percentage of revenue over
the period 2011-3Q15. As a result, we observed RAX’s Cost of Revenue has been stable with a standard deviation of 0.8%.
Therefore, we assumed the mean of this sample to be our Cost of Revenue as a percentage of sales throughout our 10-year
forecast base case. We ran a regression for the Cost of Revenue historical values against Total Net Revenue resulting in a
0.06% P-Value. This reassures that Total Net Revenue is statistical significant for determining the Base Case Cost of
Revenue percentage.
39. Research & Development – RAX first disclosed its R&D related expenses in 2011. For RAX, this item includes costs for employee and
consultants focused on the deployment of new technologies and the development/enhancement of proprietary tools. For our
forecast, we analyzed the historical behavior of this cost item as a percentage of Net Revenue over the period 2011-3Q15. The mean
value for this sample was 5.2%. We do not foresee changes in RAX’s R&D activities. Thus, we assumed the mean as RAX’s R&D
expenses as percentage Net Revenue for the Managed Hosting business segment throughout our Base Case 10-year forecast. We
ran a regression for the R&D historical values against Total Net Revenue resulting in a 0.41% P-Value. This reassures that Total Net
Revenue is statistical significant for determining the Base Case R&D percentage.
Selling, General & Administrative – For our forecast, we analyzed the historical behavior of this expense item as a percentage of
Total Net Revenue over the period 2011-3Q15. However, we deemed periods 2013 and 3Q15 to be outliers and did not consider them
for the purposes of this analysis. Excluding said periods from the sample, we observed a mean value of 31.4% with a standard
deviation of 0.3%. We assumed the mean to be RAX’s Selling, General and Administrative expense as percentage of Total Net
Revenue throughout our base case 10-year forecast. We ran a regression for the SG&A historical values against Total Net Revenue
resulting in a 0.2% P-Value. This reassures that Total Net Revenue is statistical significant for determining the Base Case SG&A
percentage.
Depreciation and Amortization – For our forecast, we analyzed the historical behavior of this expense item as a percentage of Total
Net Revenue over the period 2011-3Q15. As result, we observed a mean value of 19.8% with a standard deviation of 0.7%. We
assumed this mean value to be RAX’s Depreciation and Amortization expense as percentage of Total Net Revenue throughout our
base case 10-year forecast. We ran a regression for the DNA historical values against Total Net Revenue resulting in a 0.01% P-
Value. This reassures that these inputs have a statistical significance for determining the Base Case DNA percentage for the
forecasted period. This reassures that Total Net Revenue is statistical significant for determining the Base Case DNA percentage.
Cost of Revenue – The Cost of Revenue for this business segment will be mainly comprised of employee-related expenses, as well
as reselling charges from Third-Party Cloud providers. In this regard, for the purposes of our 10-year forecast, we estimated these
reselling charges to be equal to the projected Depreciation and Amortization expense of the Managed Hosting segment, 19.8% of its
Net Revenues. This assumption is consistent with RAX’s management guidance as expressed during 3Q15’s earnings call.
Furthermore, we expect the costs related to personnel to resemble RAX’s Cost of Revenue for Managed Hosting which translate to
a 32.7% of Net Revenues. As a result, we estimate RAX’s Fanatical Support for Third-Party Clouds to deliver stable Gross Profit
margins of 47.5% through 2025.
Selling, General and Administrative – We considered RAX’s pre-IPO and IPO years to be an adequate proxy of the amount of
resources that need to be allocated in order to best-position the new service offering. Therefore, we calculated RAX’s average
Selling, General and Administrative expenses as percentage of Net Revenues for the three-year period 2006-2008 and assumed
this value, 42.9%, for our 10-year forecast.
40. Other considerations – This business segment is characterized for a high demand of human capital and lack of infrastructure needs.
Therefore, in our forecast we do not expect RAX to incur in Depreciation and Amortization expenses or Capital Expenditures for
Fanatical Support for Third-Party Clouds. This has been confirmed by RAX’s Leadership during its last earnings call.
Accounts Receivable, net – RAX business is mainly based on a pay-as-you-use monthly model. Therefore, we assumed 30 days of
sales outstanding to calculate its net receivables, slightly above RAX’s historical figures.
Accounts Payable – Based of RAX’s number of days payable outstanding for 2014, which we assumed to remain constant
throughout the forecasted period.
Property and Equipment, net – Calculated based RAX’s Property and Equipment balance at the close of 2014, and the
aforementioned assumptions for both CapEx and DNA.
Accrued Expenses – Based on a fixed percentage of the Cost of Revenue forecasted for the Managed Hosting segment. Therefore,
we calculated this ratio for RAX’s 2014 fiscal year and assumed this value, 11.5%, for our 10-year forecast.
Other Current Liabilities – Based on a fixed percentage of the Cost of Revenue forecasted for the Managed Hosting segment. We
calculated this ratio for RAX’s 2014 fiscal year and assumed this value, 5.6%, for our 10-year forecast.
41.
42. The Altman Z-Score, developed by Edward Altman, determines a company’s financial health. For publicly traded companies, this
indicator is calculated as follows: (1.2*X1) + (1.4*X2) + (3.3*X3) + (0.6*X4) + (1.0*X5). Where:
X1 – Working Capital / Total Assets
X2 – Retained Earnings / Total Assets
X3 – Operating Income / Total Assets
X4 – Market Capitalization / Total Liabilities
X5 – Sales / Total Assets
Altman Z-Score below 1.80 – This is considered a distress zone indicating firm with a high probability of bankruptcy
Altman Z-Score above 3.00 – This is considered a safe zone, indicating firms unlikely to a high probability of bankruptcy
Based on the Altman Z-Score model, considering the financial information for the five year period 2011-2015, RAX has LOW
probabilities of filing for bankruptcy.
44. We used Forward EV/EBITDA as our independent variable and regressed it against the strongest underlying fundamentals of EBITDA
which according to Damodaran are: (i) projected revenue growth, Estimated Annual Revenue Growth in the next 2 years, we used
market consensus to capture as much information from the markets as possible; (ii) Debt/Capital, to consider differences in capital
structure; and (iii) Effective Tax Rate. Our regression analysis was weighted based on market capitalization to account for the size of
each company.
We performed several sanity checks to our model and concluded that our regression could be used to predict the value of the
multiple. In the first place, we assessed the statistical quality of the selected observations. For this we evaluated the existence of
autocorrelation among observations by applying the Durbin-Watson method and resolved that there was a healthy independence
among the chosen observations. Moreover, we confirmed no significant multicollinearity issue with the data. On the other hand, we
assessed the significance of said observations for determining the Forward EV/EBITDA. Our model’s R-Squared stands at a healthy
0.645 which means that our measures of risk and growth explain 64.5% of changes in said ratio for companies in our sample.
Furthermore, the significance level (P-Value) of 0.000 obtained shows that the regression model is a good fit of the data assuring a 95%
confidence interval (Any value below .005 is accepted) and significance for each variable individually ranging from .003 to .045 (Any
value below .05 is accepted).
The "R-Squared" represents the coefficient of determination, which is the proportion of variance in the dependent variable (Forward
EV/EBITDA) that can be explained by the independent variables (technically, it is the proportion of variation accounted for by the
regression model above and beyond the mean model).
45. The F-ratio in the ANOVA table tests whether the overall regression model is a good fit for the data. The table shows that the
independent variables are statistically significant, meaning variation in the dependent variable’s results is explained by the independent
variables as opposed to random chance (the regression model explains over 95% of variation with P-Value < .05)
We tested for the statistical significance of each of the independent variables separately. With a P-Value lower than 5%, we concluded
that the coefficients are statistically significant. The T-Value and corresponding P-Value are located in the "t" and "Sig." columns in the
table below, respectively. Values in the “Sig.” column show that all independent variable coefficients are different from 0 and thus
statistically significant
Based on our model to predict Forward EV/EBITDA we arrived at a price for this methodology of $26.81 as follows:
47. Finally, from the Monte Carlo, we concluded that the variable with the highest impact within our model is V7, contributing to 30.7% of
the variability in our price target as shown in the graph below. Therefore, RAX’s equity value could be diminished if not able to
capitalize of its current and future partnerships with third party cloud providers.
Independently from the Monte Carlo, and holding all growth variables unchanged, we performed a Sensitivity Analysis on the key
inputs underlining the discount rate and Terminal Value computations. Specifically, we tested the RAX’s Terminal Growth Rate and
WACC.
Terminal Growth Rate – For our DCF Analysis to deliver a price estimate for RAX with at least a 30% upside, the Terminal Growth Rate
must be equal to or greater than 0.69% (a decrease of 66% from the Base Case value). However, considering the 70% weight we
assigned to our intrinsic valuation model, the Terminal Growth Rate would need to decrease from 2.02% to 0.16% for us to change our
recommendation to a HOLD. Furthermore, even with a terminal 0.0% our recommendation would not turn into a SELL.
WACC - For our DCF Analysis to deliver a price estimate for RAX with at least a 30% upside, the WACC must be equal to or greater than
10.09% (an increase of 8%). However, considering the 70% weight we assigned to our intrinsic valuation model, the WACC would need
to increase from 9.36% to 10.35%% for us to change our recommendation to a HOLD. Furthermore, a WACC greater than 13.43% (an
increase of 43.5%) would be necessary to turn our recommendation to a SELL.
48.
49. During the first half of 2014, after RAX’s former CEO Lanham Napier retired, the company was rumored to be an acquisition target
for large Telcos and tech companies including IBM and HPE. Based on this event, and considering that the cloud computing
industry is characterized by a high M&A activity, we decided to conduct a brief research of the industry’s M&A track record.
Sept. 15, 2015 – Accenture (NYSE: ACN) entered into an agreement to acquire Cloud Sherpas, a leader in cloud
advisory and technology services specializing in Google, Salesforce and ServiceNow. The move will further strengthen Accenture’s
position as a cloud services provider and enhance its ability to provide clients with cloud strategy, technology consulting, and
cloud application implementation, integration and management services.
May 26, 2015 - Storage giant EMC Corporation announced the acquisition of cloud computing management software
and IaaS provider Virtustream for $1.2B. The acquisition could help the company expand its presence in the growing cloud
computing domain and improve its range of offerings.
Sept. 11, 2014 - HPE announced a definitive agreement to acquire Eucalyptus, a provider of open source software
for building private and hybrid enterprise clouds. Since introducing HPE Helion in May 2014, HP shares in private cloud grew and
was ranked as the leader in the Forrester Wave report for Private Cloud Solutions. HPE expects the acquisition to close in the
fourth quarter of its fiscal year 2014. Terms of the deal were not disclosed.
Oct. 16, 2014 - Ericsson (NASDAQ:ERIC) announced its acquisition of Redwood City, CA-based Sentilla Corp., a provider of IT
infrastructure intelligence software. The deal was aimed at enhancing Ericsson’s ability to help service providers support IT
organizations that are struggling to overcome new network complexities introduced by mobility and the cloud.
Aug. 19, 2014 - Datapipe, a global provider of cloud and managed services and a Leader in Gartner’s
Magic Quadrant for Cloud Enabled Hosting, announced its acquisition of managed hosting and cloud company
Layered Tech. The acquisition was aimed at fueling Datapipe’s continued growth and leadership in delivering
managed cloud services, as well as its expansion into the Government sector with FISMA and FedRAMP compliant
Federal cloud offerings.
Jan. 27, 2011 - Verizon Communications Inc. (NYSE: VZ) paid $1.4B to acquire Terremark Worldwide Inc., an
operator of data centers, in an effort aimed at selling more computing services to business customers. The deal came
as telecom operators are moving deeper into selling processing power, data storage and software hosting services
over the Internet as their landline businesses shrink. The acquisition could help VZ secure more cloud computing deals
and compete with companies like Amazon.com Inc.
SOURCE: Companies’ press releases
50. In order to gauge market sentiment on RAX, we used a variety of tools like Heckyl and Cityfalcon, as well as standard ratios.
According to Heckyl proprietary research, sentiment dipped mid-january when the stock was being dragged down with the market
by worries of a slowdown. We have seen so far how the sentiment has rebounded and is now trending upwards into positive
territory again (above 0)
Source: Heckyl
Cityfalcon’s data points out to an uptick in the number of stories, including a downgrade by Zacks research on their stock
recommendation. Nonetheless, sentiment on RAX has been recovering slightly despite a bigger peak later that contain positive
news such as RBC and Cowen Capital reiterating BUY recommendation.
Source: CityFalcon
Among analysts, the consensus seems to be that the stock is still a BUY, despite recent downgrades by investment firms. Out of 20
analysts in the Dataset, at least 60% rates the stock as an either BUY or OUTPERFORM with 25% rating the stock as SELL or
UNDERPERFORM.
Source: Heckyl
51. Capital IQ also shows a similar situation, with most analysts hovering around the 30 mark for RAX as a target price with a steep
drop back in August 2015 due when the stock price was closer to the 50s.
Source: Capital IQ
Of the 11 publicly disclosed analysts’ recommendations on Capital IQ: 1 advised a SELL, two more a HOLD and 8 issued a BUY on
RAX.
Source: Capital IQ
Another trend worth noting is that 80% of hedge funders tracked by Heckyl have been adding to their positions on RAX while the
other 20% have been either reducing their positions or dumping the stock all along.
Source: Heckyl
Target Price Recommendation
Evercore ISI 33.00 E Hold (3)
Analyst Schildkraut, Jonathan A. Schildkraut, Jonathan A.
FBN Securities, Inc. 31.00 E Sell (5)
Analyst Seyrafi, Shebly Seyrafi, Shebly
Jefferies LLC 33.00 E Hold (3)
Analyst McCormack, Michael McCormack, Michael
JMP Securities 55.00 E Outperform (2)
Analyst Walravens, Patrick D. Walravens, Patrick D.
Morningstar Inc. 32.00 E Buy (1)
Analyst Summer, Rick Summer, Rick
Needham & Company - Hold (3)
Analyst - Kugele, Richard
Oppenheimer & Co. Inc. 43.00 E Buy (1)
Analyst Horan, Timothy K. Horan, Timothy K.
Pacific Crest Securities-KBCM 45.00 E Buy (1)
Analyst Bowen, Michael George Bowen, Michael George
Raymond James & Associates 48.00 E Buy (1)
Analyst Louthan, Frank G. Louthan, Frank G.
Wells Fargo Securities, LLC - Buy (1)
Analyst - Powell, Gray
William Blair & Company L.L.C. - Buy (1)
Analyst - Breen, James D.
52. But still, the float for the stock has been increasingly negative, meaning a possible trend reversal and the selloff of the stock. We
attribute this partially to recent turmoil affecting the overall markets, but investors are starting to short the stock signaling a bearish
view on RAX. For the last six month short interest ratio has been on a rollercoaster, but steadily increasing the last few months.
We assessed the overall sentiment of the market for the stock as improving and this should reflect in a better short ratio over the next
few months.
n this graph we can see that for the 50 day moving average the stock has a $52.50 stock price resistance. We can also see that the
stock has broken its support of $27.00 and is now trading at $19.53.
The graph shows the trailing twelve months with its Bollinger Bands and with two overlays, the 200 day moving average and 50 day
moving average.