Niche Server Play Should Rack Up Gains

01/03/2008 12:00 am EST

Focus:

John Buckingham

Editor, The Prudent Speculator

John Buckingham of the Prudent Speculator TechValue Report says Rackable Systems' emphasis on energy-saving computing should help drive its stock price higher.

There's something to be said for being a one-stop shop for most all enterprise computing needs. Yet, there are times when a more exclusive of­fering creates a sustainable niche, such as Rackable Systems (NASDAQ: RACK).

Looking to make a clear distinction between its server and storage options and those from Dell, Hewlett-Packard, and IBM, Rackable has re-imaged its products under an "Eco-Logical" banner, with power usage, cooling needs, chassis density, and overall space requirements as key differentiators. It's a potentially risky strategy, so focused on one ideal, but it's one that may well win fans. Plus, the focus is terribly timely, as much of the tech world begins to worry about environmental impact and business expense.

The US Environmental Protection Agency [last] August estimated that servers and data centers in the US consumed 61 billion kilowatt-hours of electricity, amounting to 1.5 percent of the US to­tal, costing approximately $4.5 billion. The EPA estimates that under current ef­ficiency trends electricity consumption by data centers could nearly double again by 2011 to 100 billion kilowatt-hours, gen­erating an annual electric bill of $7.4 billion.

That's a stretch estimate, for sure, but it's a trend that's clear and troubling, one that Rackable is targeting with its newer systems.

Rackable's ICE Cube data centers currently can fit up to 11,200 processing cores or up to 7.1 petabytes of storage. Though adoption so far has been limited-Rackable says it shipped three ICE Cubes in Q3 and expects to ship three more by mid-2008-interest is growing. Intel [has said] that it was looking into container solutions, which it says can "reduce facility costs by 30% to 50% versus a brick-and-mortar installation."

The strategy is in part driving Rackable's 23% year-over-year jump in server shipments last quarter. Among Rackable's top customers are on­line retailer Amazon, social networking site Facebook, Microsoft, and Net portal Yahoo. Three [of the] longer-term customers accounted for 60% of revenue in the first three quarters of 2007. There's a plus side to that concentra­tion, though, and that's that the three are prized customers, an attractive mix long-rumored to be a driver of Dell's interest in acquiring Rackable.

But the Dell rumors have eased lately as investors have be­come more focused on operations. Somewhat troubling for the current quarter, management emphasized that it's in investment mode, intending to beef up its supply chain orga­nization. Research & development costs will be on the rise, too, [and] the marketing budget has been bolstered.

Valuation metrics for RACK shares are somewhat challeng­ing, as profitability has been light to nonexistent due to extreme price competition that's eased somewhat only more recently. On a price-to-sales basis, the stock looks quite inexpensive, trad­ing at 0.9x management's current full-year 2007 expectation for revenue. And that's before we take into consideration the long-term debt-free balance sheet currently sporting $6.25 per share in cash and [equivalents]. (RACK closed below $10 Wednesday-Editor.)

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