Rackspace Hosting (NYSE:RAX): Expect growth to accelerate, upgrading to Buy with $23 target - Goldman Sachs

Goldman Sachs is upgrading Rackspace Hosting (NYSE:RAX) to Buy from Neutral with a $23 price target (prev. $16)

Firm notes their proprietary cloud hosting pricing survey indicates that Rackspace is well-positioned to stay ahead of new cloud competition, given its value pricing and reputation for customer service. In addition, small-medium enterprise customer trends seem to be stabilizing, which sets the company up to see accelerating growth from cloud and enterprise customer growth opportunities. They see significant upside to 2010 consensus, which should help drive the 31% upside to their new $23 price target (up from $16).

Catalyst
Despite a tough macro environment, Rackspace has continued to grow through the recession as strength in cloud and enterprise has offset the slowing growth from small-medium enterprises. Recent small-medium enterprise surveys indicate that trends in this customer segment may be stabilizing. This could set a more stable base, off which cloud and enterprise opportunities can drive accelerating growth. Goldman's cloud server hosting pricing survey indicates that Rackspace has a very competitive offering, which should help it stay ahead of new competitors entering the market. As a result, they are increasing their 2010/2011 and out-year estimates to reflect the greater revenue opportunity. Goldman's new 2009-2011 EPS estimates are $0.24 / $0.43 / $0.65, from $0.24 / $0.38 / $0.56 previously.

Rackspace well-positioned to benefit from the multi-year cloud opportunity. Goldman expects the adoption of cloud hosting services to be a multi-year process, as customers get increasingly comfortable relying on a virtualized environment for their infrastructure needs. Rackspace, along with Amazon, has an early mover advantage in the field, which positions it well as the market continues to expand. They expect cloud computing revenues to grow to $99mn, up 73% y-o-y, representing 13% of Rackspace revenues by 2010 YE). While this is still a small proportion of their revenue mix, they expect cloud computing to account for 24% of the incremental growth in 2010.

Rackspace to stay ahead of new competition. Recently, there have been investor concerns around whether Rackspace can gain on Amazon’s market share and stay ahead of the increasing number of players who are looking to partake in the growth opportunity. While Goldman believes the market is expanding fast enough that market share shifts have a lesser effect for now, nonetheless, the new competitors are a factor to consider for market share shifts down the road. Terremark, Hosting.com and Bluelock have recently launched their VMWare-based vCloud express offerings and Savvis has announced its beta launch of its cloud initiative as well. There have also been a host of smaller private players such as GoGrid and Softlayer who are competing in the same market. Based on their analysis, they believe that Rackspace’s headstart (over the new competitors), its current managed hosting scale and its reputation for customer service, should allow it to fend off new entrants, while competing effectively with Amazon.

Notablecalls: RAX is a mover stock and getting a blessing from Goldman Sachs will propel this one to a new high, I suspect.

Cloud computing is the new hype word these days and RAX is still trading 0.5x EV/EBITDA vs. 2x EV/EBITDA of CRM for example.

I see RAX trading over the $18 level today with $18.50+ seemingly prudent as an intraday target.

Should RAX keep performing, I see Goldman taking their target higher towards $30 range over the next couple of qtrs.