Wednesday, January 17, 2007

Color on warning: Rackable Systems (NASDAQ:RACK)

Couple of firms are out on Rackable Systems (NASDAQ:RACK) after the co issued a negative pre-annoncement last night:

- First Albany notes management attributed the EPS shortfall to unfavorable DDR memory pricing, intense competitive conditions, and lower-than-expected sales of the RapidScale products. Given firm's observations of favorable CPU and improving DDR2 pricing, they believe the margin shortfall was driven primarily, if not almost exclusively, by the intensifying competition within the x86 space.

The company will update its FY07 guidance during its earnings call on February 1, but they remain concerned about Rackable's competitive position. Dell (DELL), the firm believes, will almost certainly expand its AMD-based (AMD-$18.13-Not Rated) offerings. Supermicro, Rackable's tier-two peer, has recently announced server offerings that appear to match Rackable's value proposition in density and power efficiency. Despite the growth opportunities in the clustered storage space, they remain cautious of Rackable's competitive position, given its inexperience relative to the pure-play storage players.

Given the negative preannouncement, they are reducing estimates. FY07 EPS estimate goes $0.89 on $481M in revenue from $1.33 on $503M, respectively. Reiterates Underperform rating.

- RBC Capital notes they suspect the memory pricing issue is temporary given our view that DDR memory pricing will soften in 2007 as memory manufacturers ramp more production in anticipation of Microsoft's Vista launch. Consequently the comments on competitive dynamics and the timing of RapidScale appear more relevant to the forward outlook.

Firm has lowered their 12-month price target to $30 (was $40). They assume a probable, though not certain, FTM price downside/ upside scenario of $15/$40 (was $20/$60) on exection below/above their new estimates. Firm continues to rate the shares Outperform with a Speculative risk assessment on a 12-month basis, but their rating is subject to change near term pending greater clarity on competitive dynamics at top customers.

- Piper Jaffray says they believe large OEM competitors such as Dell and Sun Microsystems were aggressively discounting during the quarter and this is creating a pricing war in the high density server market. They believe Rackable had no option but to lower prices to retain current customers and this is resulting in significantly lower gross margins.

Rackable also experienced increases in prices of certain components, especially DDR memory, which had a negative impact on the gross margins during the December quarter. They believe the component pricing problem was magnified due to higher use of the DDR2 memory in newer systems based on Intel Woodcrest platform and AMD's Socket F platform. Maintains Mkt Perform. Tgt goes to $26 from $31.

Notablecalls: RACK continues to be a controverial name. Just check out the archives for NC comments. The cold hard fact here seems to be that DELL and SUNW are able to buy CPU's and memory at much lower prices than RACK can. An uphill battle. RACK needs to differentiate itself from the competition. I have no idea how they could do it. I suspect RACK's management doesn't either. At least not at this point. I have very little feel for the stock in the s-t. Given its sizable short interest and the 10 point haircut it receieved in after hrs trading I would not be surprised to see some short covering around these levels.

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