Cloud business growth to erode margins for Rackspace

Web hosting company Rackspace Hosting Inc's investments in its cloud business were going to erode margins, its top executive said.

"Cloud computing" — one of the hottest buzz words in Silicon Valley — refers to a variety of ways in which technology companies offer computing services over the Web from remote data centers, seemingly from the cloud of the Internet.

Rackspace manages customer hardware and software with its managed hosting service, its biggest segment, and lets customers host websites and rent "virtual" servers through its cloud business.

"We believe that the cloud is a game-changing paradigm shift," Chief Executive Lanham Napier said in an interview with Reuters.

The cloud business, which contributed 10% to revenue in the third quarter, has been growing in excess of 100% per year.

"Anytime we are having that kind of a growth rate I suspect we will be making outsize investments, trying to get ahead of that growth, which will put pressure on margins."

In the third quarter, Rackspace recorded adjusted earnings before interest, taxes, depreciation, and amortization margins of 31.7%, flat quarter over quarter. Its cloud business grew 17% from the second quarter.

Another area of growth for the company, which has historically focussed on small and medium-sized business, has been the large enterprise managed hosting segment, where its rivals include IBM and Hewlett-Packard.

Napier said the impact of more business from large enterprises on its margins was likely positive.

The company, which competes with Amazon.com, Joyent and GoGrid in the cloud market, has been faring well against rivals, Napier said.

"We have increased our competitiveness in 2009. Relative to certain competitors, we're absolutely gaining market share," Napier said.

Rackspace has been closing the gap with Amazon, he said.

Shares of the San Antonio, Texas-based company have risen 233% since the start of the year.