Sunday, October 28, 2007

Rackable Systems New Friend: Facebook

Rackable Systems (RACK) reported Q3 2007 results that showed a second quarter of good revenue improvement and brought the company back from serious losses to break-even. Management reported that at the end of the quarter the backlog of orders had reached a record high. And just in case the analysts covering the conference missed the point, Rackable named the four customers that buy the most equipment from them: Microsoft, Yahoo, Amazon, and Facebook.

Before looking at Facebook and other opportunities, recall that RACK stock has been very volatile (See chart at NASDAQ). In the past 18 months it has been over $50 and as low as $11.25. The highs were reached after Rackable ramped up its highly efficient server system sales in the previous few years. The lows came after bigger server-market players took notice and started low-balling bids on systems, causing Rackable to lose sales and to lose profit margins on some sales that took place (See Rackable, Playing With the Big Guys, April 5 2007). Rackable had to restructure and write off inventory as obsolete. So in 2007, Q1 saw a plunge in revenues and heavy losses; Q2 saw a sequential increase in revenues and heavy losses; and Q3 saw a second sequential increase in revenues and break-even on earnings.

So where do we go from here if we take a ride with Rackable? (Note that I own stock in the company.) It depends on how well Rackable does against its competition. Rackable pioneered energy-efficient server farm designs, but its equipment is not the cheapest on the market. Its servers are easy-to-manage, and it now has some new, very innovative products. One is that is has a line of servers optimized for virtualization, which is a big industry trend. It also has ICE Cube, what might be called a server-farm in a box. These are your basic cargo containers filled with servers. You can buy a server farm ready to go and just put it in the parking lot; there is a lot of interest, and only one other company is trying to compete in this space so far. Once built an ICE Cube server farm uses far less energy than a conventionally warehoused system.

Another boost going forward will further enhance Rackable's reputation for being the leader in Green computing (their slogan is "Enabling the ecological datacenter") is the release of new server systems using AMD quad core Opteron processors. Rackable started as an AMD-only company, then added lines using Intel processors that became substantial over time. Conservative customers, and IT departments whose decision makers own Intel stock, still have Intel-only buying policies. But management confirmed that demand for AMD quad-core based servers is high and systems will be shipping this quarter (I am guessing that is the reason for the record level of backorders). The AMD chips are better designed than the Intel chips and so deliver more overall computing power with less energy consumption.

It is interesting that Google is not a Rackable customer. As the largest Internet company, you would think it would be in there with Microsoft, Yahoo, Facebook and Amazon. Google succeeded in part by stringing a lot of cheap servers together with their own proprietary methods. I'm betting those servers are very un-Green, very energy inefficient, but for now Google is so profitable it probably is not concerned much about its electric bill.

Facebook suddenly has a bunch of cash from Microsoft's buying a part-interest, so don't be surprised if they use some of it to build out their server farms. Microsoft has announced plans to greatly increase their Internet presence, so they will be expanding their server farms as well. And Yahoo and Amazon are expanding too, if not quite at Google's pace.

So I think Rackable systems has a good chance of being an emerging success story in 2008. However, you should be aware that the stock is risky. Rackable is planning on spending a lot of money on expansion; in the short run that will mean even if revenues ramp up, earnings may be negligible. Rackable is playing against formidable competitors like Sun, HP, Dell, and IBM, so they are not guaranteed to win.

Always keep your portfolio well-diversified.

More data:

Rackable web site
My Rackable page
My pages on others companies in this article: AMD, Intel, Sun, HP, IBM, Dell, Yahoo
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