RAX - Rackspace (REIT vs non-REIT)

[PatientCheetah]

Similar to Amazon, Rackspace rents out computing powers to others and run data centers. It was richly valued and has recently fallen on hard times due to pricing pressures coming from Amazon, Google, and Microsoft, all of which has better economies of scale.

 

Two of its competitors, Equinix (EQIX) and Digital Realty Trust (DLR) have similar business models but have held up much better due to their REIT status. If they have similar economics and face the same competitive pressure, I understand REITs are valued based on their funds from operations (FFO) but does REIT status really change valuation this much? Shouldn't they eventually converge somewhat? Maybe there are other important fundamental business that I have missed?

 

What stands out to me is the rapid and persistent increase in long term debt and the negative free cash flow. For these with more experience with REITs, is this normal? DLR is particularly egregious in this regard and appears to be funding its dividends through debt issuance.

[no_free_lunch]

This just seems like a very competitive space, I would be cautious.  I recall reading that Google is now entering into price wars with amazon of all companies just to grab market share.  I realize google's offerings are different from rackspace but nevertheless i see increased competition from the big guys (amazon/microsoft/google) to take market-share.  They are likely thinking about cross-selling as well so may be willing to operate break-even or at a loss.

[PatientCheetah]

This just seems like a very competitive space, I would be cautious.  I recall reading that Google is now entering into price wars with amazon of all companies just to grab market share.  I realize google's offerings are different from rackspace but nevertheless i see increased competition from the big guys (amazon/microsoft/google) to take market-share.  They are likely thinking about cross-selling as well so may be willing to operate break-even or at a loss.

 

I am actually thinking about shorting DLR or EQIX and want to time it well. Their existence requires the capital market remaining open to them. If their new debts start to go up in rates or the debt market for some reasons becomes more selective, it could be the trigger.

[tradevestor]

Equinix is different.  This article explains it.

 

http://www.institutionalinvestor.com/blogarticle/3310914/How-I-Bought-the-Internetand-You-Can-Too.html

[writser]

I'm extremely sceptical about that. No matter how you slice and dice it, a hosting provider just puts a bunch of computers in a warehouse and rents them out. Not a big moat, huge capital expenditures, no stellar returns and lots of competitors. Do you really think that the Equinox concept is so fantastic that Amazon, Google, Microsoft and the likes can't replicate it? This might be a better company than Rackspace but it has a very high valuation, no FCF, a mountain of debt and terrible ROIC (as has Rackspace .. ). In the end hosting is just a commodity business imo. These companies are pretending to be part of the cool club: the social media / cloud computing guys, but they are not. Best case they grow into their current (excessive) valuation and you make a little bit of money. Worst case you lose a lot.

[ItsAValueTrap]

Rackspace, when I looked at it, struck me as being pretty well managed.  The industry is a bit of a commodity industry but there are areas where Rackspace and create value and find efficiencies.

 

I think where Rackspace is good at is with small customers.  They are service-intensive, which plays to Rackspace's strengths.  The game is about providing good service in a cost-effective manner.

 

Google and Amazon are strong in areas where somebody needs lots and lots of servers rather than just one or two.  They are creating value by finding efficiencies in the technology.  Google for example figured out that it could use a battery near the computer instead of a UPS.  It figured out that having naked servers helps cooling and saves money on the case.  It figured out that it could get rid of certain chips on the motherboard.  Amazon is doing similar things.

Some services use storage space a lot.  Other services are CPU intensive, but don't use a lot of storage space.  There are some efficiencies to be gained from increasing the utilization rate of your servers, so that each individual server is using up its storage and CPU capacity.

 

*I'm the idiot that used to short RAX and DLR.  I still think DLR is bad; I made a mistake in shorting RAX.