Private Cloud And AI Adoption Will Open Future Markets

Key Takeaways

• Record-breaking sales bookings in private cloud and focus on high-growth sectors could lead to sustainable recurring revenue and improved profitability.
  
• Strategic emphasis on services in public cloud and innovation in hybrid solutions may enhance margins and future market share.
  
• Rackspace's profitability faces pressure due to declines in private cloud revenues, lower margins, and negative free cash flow, posing potential growth challenges.

Catalysts

Operates as a multi cloud technology services company in the Americas, Europe, the Middle East, Africa, and The Asia-Pacific region.

• Rackspace has achieved record-breaking sales bookings, particularly in the private cloud sector, which grew significantly in the fourth quarter. This strong bookings performance is likely to lead to increased recurring revenue, as larger deals under multiyear contracts build a sustainable revenue base.
  
• The company is focusing on the healthcare, sovereign, and AI markets, which showed substantial year-over-year revenue growth (34% in healthcare and 59% in sovereign). These high-growth sectors could improve Rackspace's overall revenue and profitability.
  
• Rackspace's strategic shift to a services-led sales motion in the public cloud segment, emphasizing services over low-margin infrastructure resale, may drive higher margins and improved earnings.
  
• The launch of new solutions, such as Rackspace Anywhere and the Open Cloud, positions the company to capture additional market share in hybrid cloud solutions; this innovation is expected to impact revenue growth positively and enhance operating margins.
  
• Adoption of AI services has started contributing to revenue, with expectations that AI will grow to represent a more significant portion in the future. As AI adoption accelerates, this could positively influence earnings and margins due to the high value of AI solutions.

Rackspace Technology Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Rackspace Technology's revenue will grow by 1.1% annually over the next 3 years.
• Analysts are not forecasting that Rackspace Technology will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Rackspace Technology's profit margin will increase from -31.4% to the average US IT industry of 7.9% in 3 years.
• If Rackspace Technology's profit margin were to converge on the industry average, you could expect earnings to reach $224.2 million (and earnings per share of $0.8) by about April 2028, up from $-858.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 5.1x on those 2028 earnings, up from -0.4x today. This future PE is lower than the current PE for the US IT industry at 30.3x.
• Analysts expect the number of shares outstanding to grow by 6.01% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.41%, as per the Simply Wall St company report.

Rackspace Technology Future Earnings Per Share Growth

Risks

• Rackspace is expecting a modest year-over-year decline in private cloud revenues for fiscal 2025, which could impact overall revenue growth in this segment.
  
• Non-GAAP gross profit margin decreased year-over-year by 172 basis points, indicating pressure on profitability that could affect net margins.
  
• Despite strong bookings, non-GAAP operating margin was down 146 basis points for the full year 2024, which highlights potential challenges in maintaining profitability as the business scales.
  
• Rackspace's reliance on public cloud infrastructure resale comes with lower margins, and fluctuations in this area can affect overall earnings adversely.
  
• Free cash flow usage was negative for the full year, suggesting potential liquidity constraints, which could impact capital investments and future growth opportunities.

Valuation

• The analysts have a consensus price target of $2.95 for Rackspace Technology based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $3.5, and the most bearish reporting a price target of just $2.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $2.8 billion, earnings will come to $224.2 million, and it would be trading on a PE ratio of 5.1x, assuming you use a discount rate of 11.4%.
• Given the current share price of $1.35, the analyst price target of $2.95 is 54.2% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.