Summary: Rackspace reported its 2Q16 results, which were modest on the top-line due to foreign exchange headwinds and some divestitures of non-strategic assets. But the healthy forward trajectory of the business is not in doubt as Rackspace showed continued progress on the bottom line and is generating more cash and spending less on CapEx as a percentage of revenue.
Details: Revenue came in at $523.6m, up 7% y/y and 1% q/q. Taking into account foreign exchange impact and the divestiture of the Jungle Disk business, growth would have been 8.9% y/y and included an additional $9m in revenue. Moving to the bottom line, adjusted EBITDA margin was up, coming in at 35.8%. Adjusted EBITDA was $187.3m, up 4.5% y/y. The fundamentals remain solid. Free cash flow hit a high of $98m and CapEx as a percentage of overall revenue was 15.7% versus 31% a year ago. The impact of an increasingly asset-light model, more efficiency with new platforms and increased utilization are kicking in.
Full-year headwinds: Rackspace projects full-year negative impact of $70m due to foreign exchange and asset divestitures.
Enterprise: Rackspace continues to move its focus up-market. The number of mid-market and enterprise customers signed in the first half of the year was almost double from a year ago.
Brexit: Management also referenced some negative impact from the Brexit vote.
Managed third party cloud data points: Rackspace provided some more data points around managed third party cloud. For managed AWS, Rackspace has signed 277 customers since October of last year through July 2016. Interestingly, Rackspace says managed AWS customers are roughly evenly split between existing Rackspace customers and net new additions. This is a bit different from what we’ve seen at other providers that tend to have many more net new customers. This could be a function of the fact Rackspace simply has more customers than most providers. Very notably, these managed AWS customers are bringing incremental workloads to Rackspace. They are not moving from existing Rackspace cloud or managed bare metal services. In fact, management was quick to point out that a focus of its strategy will be winning new AWS workloads from existing Rackspace customers. Finally, Rackspace noted that over 60% of customers on managed AWS are choosing the highest level of service – a good indicator of the quality of the demand that is out there. Nearly 50% of customers are coming from outside the US.
Cannibalization: Rackspace made some interesting comments about cannibalization. It has not seen any cannibalization effects so far when it comes to managed third party cloud. And this matches up with its experiences with its own public cloud.
Lead gen on third party cloud: An interesting comment from management was that most of the demand it has seen for managed third party cloud has been ‘self-generated’.
Azure: Not much mention was made of managed Azure though management referenced gains of ‘increased traction’ here. It seems to be doing better with Azure and Windows-based private cloud at the moment.
Cloud momentum: Rackspace reiterated its outlook on Rackspace’s public cloud. Demand has slowed but demand for OpenStack-based private clouds – hosted or on-premise – is encouraging.
Private equity buyout: Unsurprisingly, management did not comment on recent rumours regarding its potential sale to a private equity firm. There is nothing new here.
Server count: The server count was again down on a q/q basis as Rackspace retires more aging infrastructure and moves customers to the new cloud platform.
Rackspace 2Q16 (revenue in $m USD, except for ARPU per server; servers, employees are actual figures)
| 2Q16 | 2Q15 | 1Q16 | Y/Y% Change | Q/Q% Change | |
|---|---|---|---|---|---|
| Total Revenue | 523.6 | 489.4 | 518.1 | 7.0  |
1.0 |
| Servers | 114,231 | 116,329 | 116,507 | 1.8  |
2.0 |
| ARPU Per Server | 1,513 | 1,416 | 1,472 | 6.9 |
2.8 |
| Employees | 6,199 | 6,115 | 6,203 | 1.4 |
0.0 |
| Net Annualized Revenue per MW | 65.3 | 62.5 | 64.5 | 4.5 |
1.2 |
Source: Rackspace filings
Rackspace 2Q16 (all figures in $m USD)
| 2Q16 | 2Q15 | 1Q16 | Y/Y% Change | Q/Q% Change | EBITDA Margin | |
|---|---|---|---|---|---|---|
| Adjusted EBITDA | 187.3 | 160.3 | 178.5 | 4.4 |
4.9 |
35.8% |
Takeaways:
- normalized growth was 8.9% y/y
- net income was $35.8m, down from $48.8m
- adjusted free cash flow was $98m in the quarter, up from $94m
Guidance: Rackspace adjusted guidance due to the many moving parts. Revenue is projected to come in at $2,060-2,080b or 3-4% y/y growth. Adjusted for ForEx and asset divestitures, growth is projected at $2,130-2,150b or 4.9-5.9% y/y growth.
Angle: Rackspace has a lot of moving parts swirling around it to say the least. The past quarter was again all about managed third party cloud. Rackspace is dead set on this market and wants to be the leader and will launch a ‘bold’ marketing campaign to support these efforts. Notably, management made mention of Datapipe on the earnings call as a market leader. The bet is a big one and the asset-light model enables Rackspace to pursue opportunities and growth paths. Three come to mind: 1) it will help Rackspace grow existing customers by getting more incremental workloads; 2) it will allow Rackspace to tap into a rapidly growing market that will inevitably have a prominent managed services and support demographic within it; and 3) it can attack other markets where it is weaker – like continental Europe – without having to invest too heavily. Rackspace is in transition, but the model it is building into its business is an efficient one that has unique scale and efficiency benefits that it is already showing signs of taking advantage of.