New Customers Boost Growth at Rackspace

With its focus on support, managed hosting specialist Rackspace (RAX) strives to create "customers for life" that expand their business over time. That formula has worked well in helping the company build revenues of $362 million in 2007. But late last year, as management looked ahead to 2008, Rackspace made a strategic decision to step up its marketing, believing that new customers would be crucial to maintaining revenue growth as the economy slowed.

That decision helped Rackspace report solid growth yesterday in its first earnings report as a public company. The San Antonio company reported second quarter revenue of $130.8 million, up 9.4 percent from the first quarter and 55.7 percent from the same period in 2007. Rackspace raised net proceeds of $144.9 million from its IPO last month.

In yesterday's conference call with analysts, Rackspace president and CEO Lanham Napier noted the "challenging macroeconomic environment" but said the company's stepped-up customer acquisition had paid off.  During the second quarter the company's customer count grew by 6.1 percent to more than 33,600. 

"We are absolutely feeling the headwinds (in the economy)," said Napier. "We've experienced a slowdown in our existing customer rate. Customers' businesses are not growing as fast, so they're not signing up for new services as quickly. The reality is that conditions this year are worse than last year. Basically, we said we were going to focus on new customer acquisition to make up for that slower growth among our customers."

Napier said Rackspace's e-mail and cloud hosting business units, Mailtrust and Mosso, are each growing in triple digits. "We are not trying to make these businesses profitable today," he said. "We are planting seeds for the future. It's about traction in the marketplace. We're going to continue to make investments there because we're pleased with their progress."

Rackspace said it is reducing its estimated capital expenditures for 2008 to $310 million from $335 million, deferring $10 million in office space construction into  2009. Rackspace budgeted the remaining $15 million in capex to prepare for equipment price hikes that have not materialized. The new estimate also includes the capital to build out the company's new Hong Kong data center.

Napier said he expected some pricing pressure on what he called the "low end" of the managed hosting market. "On the low end of our business, the price competition has increased," he said. "The way the mom-and-pops compete with us has always been on price. The only lever our competitors have is price. Rather than win the deal at a loss, we'll let it go. We have one of the best cost structures in the industry, and if we're not going to make money on a deal, we don't think our competitors will like it for long, either."

Shares of RAX are down 73 cents to $9.97 in early trading today, a decline of about 7 percent for the session.