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Should You Invest in Pure-Play Hosting Companies like DOCN or RTX? Analysis Says...

Stock MarketWhen looking for pure play hosting companies to analyze, there aren’t many with public financials.  The largest public webs are all components of larger companies.  AWS is part of Amazon, Azure is part of Microsoft, and Google Cloud is part of the Google empire.  Even if you break out the hosting part (to the extent details are reported), these giant clouds are pees but there aren’t really competitors.

Next tier down you’ve got some pure-play companies such as Rackspace (NASDAQ – RXT) and DigitalOcean (NYSE – DOCN).  Over the past 4 years and 3 years respectively, these companies have grown 50% and 100%, with Rackspace starting from a much larger base.

Neither company seems poised for profitability any time soon.

However, there’s a difference.

DigitalOcean

DigitalOcean has been increasing its R&D every year.  Over the last twelve months, they’re losing as much as they’ve lost every year.  Granted, it’s a smaller percentage each year because they’re growing.  Still, after three years, you have to ask why their model isn’t paying huge returns by now.  At their valuation (66x earnings!) they should be well into the black by now, right?  It’s not just being profitable – their valuation implies they’re poised to rain cash on shareholders.  Hasn’t happened yet.

However, they will eventually grow to profitability.  Something strategic might happen – e.g., marrying them with someone else.  Although they’re overpriced and don’t have that hypergrowth factor, you can make a case they’re at least on a trajectory.

Rackspace is different.  Very different.

Rackspace

They have been steadily decreasing its spend on Research and Development every year, spending 25% of what it spent four years ago.   That is an…interesting approach for a cloud enterprise.  They suffer from $3.4bn of long-term debt, which saps $200m from their income every year.  Private equity bought the company in 2016 for $4.3bn…these numbers are probably not dissimilar for a reason.

If you add in that $200m in interest – which for all we know is debt held by the PE crowd that bought and then re-IPO’d the company in 2020 and hence is sort of “money to the owners” – then Rackspace is barely in the black.  Things that make you go hmmm.

Unfortunately, I can’t see Rackspace even treading water in an insanely competitive industry by spending less and less every year on R&D.  That fact alone makes their future dim.

Any other pure plays I should look at?

2 Comments

  1. Niranjan Pandit:

    What about Vultr, Hetzner, Linode (now taken by Akamai), Scaleway?

    All of them have substantial presence in vps hosting industry.

    Profitability of all these players is directly proportional to the awareness and involvement of mass consumers.

    Merely a couple of decade ago, nobody even thought of hosting their own website, let alone a vps. IMHO, all the speculations of the investors are dependent on the mass consumption of hosting services. This awareness has to grow for the overall consumption to grow.

    July 9, 2022 @ 6:35 am | Reply
    • Of those you list, only Akamai is a public company, and there you’re mostly buying a CDN business, not hosting.

      July 9, 2022 @ 10:22 am | Reply

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