Rackspace (RAX) Buyback Could Reduce Sharecount by 15% - Wells Fargo

Wells Fargo analyst, Gray Powell, met with Rackspace Hosting Inc. (NYSE: RAX) management including: John Engates - CTO, Erik Carlin – VP Product, and Winston Len – VP Finance. They discussed issues impacting RAX’s core dedicated hosting and public cloud units and came away cautiously optimistic on the sustainability of growth in those businesses.

With lower capex, RAX should be able to translate 6% reported revenue growth into almost 35% unlevered FCF growth (i.e. EBITDA less capex) in 2016. Furthermore, given the pace of RAX’s current buyback, the company can shrink its share count by 15%+/year.

RAX has been in the market offering support for customers on AWS for about five months. Early adoption has been strong with RAX signing over 100 customers with the majority of customers new to the company. RAX would not give details on the average monthly spending of these customers but noted that customers range from SMB’s to larger enterprises and stated that they have signed at least one six figure/month deal. RAX also highlighted that 70% of customers are opting into the higher cost Aviator support tier which starts at a $2,250 monthly fee for support. While it is still early in the adoption cycle, we think RAX’s 3rd party cloud initiative could supplement its long term growth rate by 300 bps/year.

RAX stressed that it is winning AWS deals because customers want to be able to pursue a multi-cloud strategy and that RAX is one of a few companies that can support the strategy at scale. RAX also highlighted that other support organizations deploy customers in customized configurations that are difficult to scale and potentially do not benefit from enhancements to the AWS platform. In contrast, RAX offers a very strong opinion on best practices and has a set of pre-configured AWS templates that it feels offers greater flexibility for customers’ longer term.

No change to Outperform rating.

For an analyst ratings summary and ratings history on Rackspace click here. For more ratings news on Rackspace click here.

Shares of Rackspace closed at $21.15 yesterday.

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