Why Rackspace Hosting, Inc. (RAX) Won’t Be a Rock Star Stock

Rackspace’s biggest problem

Perhaps the biggest problem Rackspace faces is that it is competing in a commoditized business without the inherent ability to compete on price. Mind you, Rackspace’s products compete directly with Amazon’s, a company which has a shareholder base that cheers it on every time Jeff Bezo’s brainchild posts a bigger quarterly loss.

Amazon has the lower cost of capital. It can undercut Rackspace at every turn and keep its shareholders happy. Rackspace doesn’t have that ability as demonstrated by shareholders’ response to its latest earnings report.

Investors should be reminded that Amazon isn’t Rackspace’s only problem. It’s just one of many. There are thousands of hosting companies out there, all with the same servers from the same company, fiber from the same sources, and IT workers trained by the same schools. There is virtually no differentiation between one cloud company and another.

If it weren’t for the high tech appeal, Rackspace would be put in the same column as airline stocks for being certain to generate negative economic returns on capital. Investors, however, cannot deny the appeal of technology, even if the business is really just basic leasing under a different name.

The bottom line

Rackspace shareholders should look out below. The company can either compete on price, cannibalizing its share price, or hope to fool smart customers into paying too much for a commodity product. Neither option makes for a particularly good choice for your investment capital. Stay clear.

The article Why Rackspace Won’t Be a Rock Star Stock originally appeared on Fool.com and is written by Jordan Wathen.

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