Psst! Mister. You wanna buy some cloud? Cloud computing that is.
It is the wave of the future in the delivery of everything from computer software to media products to computer services. Market researcher The 451 Group estimates that revenue for infrastructure as a service, one of the two big categories of cloud computing will grow to $1.2 billion a year by 2013 from $200 million last year. Data storage in the cloud, the other big cloud computing segment, will see revenue climb to $1.7 billion in 2013 from $150 million in 2009, the group estimates.
Even Microsoft (MSFT) in its current update to its cash cow Office 2010 software is taking steps toward the day when most people will buy most of the software they need over the Internet as a service that’s resident on big server farms scattered around the world.
But as survivors of the telecom boom (and bust), the dot.com boom (and bust) and, going even further back, the disk drive boom (and bust) know the future waves in technology can leave investors drowning in a sea of red ink.
So how do you invest in the cloud without getting rained on?
The riskiest but also the highest payoff route involves putting money in one of the small and relatively young companies that are offering tailored, premium services to customers. Often big customers.
For example, there’s SuccessFactors (SFSF), which recently signed a deal to provide Wal-Mart’s 2.1 million employees with cloud-based software to manage employee performance. The deal follows a SuccessFactors trial with 300,000 employees.
Another company at a similar state of development but that does business in a different part of the cloud is Rackspace Hosting (RAX). Companies use Rackspace’s servers to provide storage in the cloud, rather than on computers and storage devices at the company, email in the cloud, and software applications in the cloud. Rackspace tailors its hosting services to the needs to individual customers for specific mixes of company-resident and cloud-hosted applications and storage.
Salesforce.com (CRM) is one of the pioneers of software as a service. Its Sales Cloud 2 product puts applications for accounts and contacts, marketing and leads, opportunities and quotes, email, and other sales tools in the cloud. Its Service Cloud 2 product uses the cloud to host a wide variety of communities for customers and sales reps and service specialists.
From my perspective there are two big drawbacks to these cloud companies as stocks.
First, they’re expensive.
Rackspace sells for 48 times projected 2010 earnings per share. (Its projected five-year earnings growth rate is 23% a year so its PE to earnings growth (PEG) ratio is 2.1.) SuccessFactors isn’t forecast to be profitable in either 2010 or 2011. (Its projected five-year earnings growth rate is 29%.) Salesforce.com sells for 156 times projected 2011 earnings per share. (Its projected five-year earnings growth is 31% a year. That’s a PEG ratio of 5.03)
In contrast software maker Oracle (ORCL) trades at 12.5 times projected 2010 earnings per share. Its projected five-year earnings growth is 13.6% a year. With PEG ratios it is the lower the better. A low ratio shows that an investor is paying relatively less for a company’s future earnings growth. And in this case Oracle’s PEG ratio of .92 shows just how expensive growth is for these other stocks.
If you’re buying a Rackspace or a SuccessFactors at these prices I think you’re hoping that some big software company is going to buy the company at a premium. (Salesforce.com is, I think, too big and too pricy to be a likely acquisition candidate.)
And second, these companies are selling premium products in a market where off the shelf products are getting cheaper and more powerful day by day. These companies defend their strategies by saying that they provide a degree of support or customization or service that cheaper cloud products don’t offer.
I think that’s true in the short run. But as Japanese, Korean, and Chinese companies all demonstrate, once you build up a huge market share at the lower end of the market, it is relatively easy to move higher and higher up the price and product chain. Once everyone is buying the Camry, Toyota can successfully launch the Lexus and the Prius.
So who might be the Toyota of cloud computing?
My vote would go to Amazon.com. The company has built up tremendous scale in this space in creating the infrastructure for its own electronic retail businesses. And Amazon is now selling cloud hosting services to big and small companies. Granted the services aren’t as customized as those sold by a Rackspace or a SuccessFactors or a Salesforce.com, but the prices are extremely low. JubakPicks.com uses Amazon to serve all the photos on the site. The bill is $15 to $20 a month.
Amazon doesn’t break out the revenue it gets from selling processing power to customers (mostly small and midsize businesses), storage in the cloud, and cloud-based management of data bases, Web stores and networks.  The Forester Group guess-timates that Amazon’s revenue from this business (called AWS for Amazon Web Services) came to $350 million in 2009. That compares to trailing 12-month sales of $1.4 billion at Salesforce.com, $663 million at Rackspace, and $162 million at SuccessFactors.
But in its recent shareholder meeting Amazon management said that it believes that Amazon Web Services could eventually grow to be as big as its core retail business. Amazon recently sold for 41 times projected 2010 earnings per share. Its projected five-year growth rate is 34% a year. That puts the PEG ratio at 1.2.
Not cheap but with the realm of reasonable if this is the Toyota of cloud computing.
Full disclosure: I don’t own shares of any company mentioned in this post.
dpriebe,
Many of the larger companies (such as banks and defense contractors) face regulatory hurdles that prevent them from using cloud computing, until it can be proven to be as secure as WANs. In addition, many people simply don’t trust the security of the Internet.
Until a large business can make the case for the inexpensive use of cloud computing, you won’t see many companies trying it. All it will take is one breach of a big company’s records in cloud computing to send a CIO to unemployment and the rest of the Fortune 500 CIO’s running scared.
“I believe it would be accurate to assume that many companies will be utilizing the cloud to save money and focus on their core competency.”
Bingo.
The cloud concept is pretty simple:
1. Services (applications, for the sake of simplicity) can be put up in the cloud and are essentially globally available. Good for very large companies and very large customer bases (including “internal” customers).
2. Computing and storage are highly flexible on a minute-to-minute basis. Good for fast-growing companies or products with spikey access or processing needs (media, e-commerce, research and engineering).
Some of the other details include:
Commodity hardware. I shouldn’t have to care what physical device(s) my service is running on. The cheaper the better, installed cost as well as running cost. (http://venturebeat.com/2010/06/13/seamicro-drops-an-atom-bomb-on-the-server-industry/)
Flexible software. There are a lot of flavors. Windows Azure. Google App Engine. Amazon EC3. Hadoop. Cassandra….
Interestingly, a lot of this is free open-source software (not Azure, obviously). The money is in the server infrastructure, power, HVAC, real estate, routers, and big data pipes. It’s capital intensive. There’s also considerable investment in custom coding and system management. Some pretty specialized expertise is needed.
Here’s one place where Microsoft may have an advantage with Windows Azure. Software developers with Microsoft .NET experience should be able to very easily start building applications for the Azure cloud or moving existing .NET applications to Azure with minimal additional investment in knowledge or re-coding applications. (In very basic terms, .NET is a set of building blocks that let programmers create applications more easily than writing everything from scratch. It’s also very Windows-centric.)
As for security… I don’t see security as being a technical hurdle to cloud adoption. Psychological, sure. But the security issues have less to do with the cloud platforms and datacenters and more to do with people — specifically software developers, disgruntled employees, and human folly in general. In other words, the problem remains internal to the company for the most part.
Going back to dpriebe’s quote, it’s all about money. Software developers are way cheaper than datacenters, and much easier to dispose of when you’re done.
Ed – you are vastly underestimating the implications of cloud computing if you don’t think that corporations will buy in. Many already are and many companies are considering it since it’s so much cheaper.
Life – Also, Nicolas Carr is not exactly a mainstream tech voice. However, I believe it would be accurate to assume that many companies will be utilizing the cloud to save money and focus on their core competency.
I’m shocked that Vmware and Akamai were not mentioned in the article.
Derrick
Christopher, thanks for the link. Pretty complicated stuff for me to digest. Not sure if the security issue could ever provide 100% confidence to customers’ concerns. 60 Minutes recently did a piece on internet security: Thousands of attcks per day to national defense, banks, electrical grids, etc. $100 million stolen through hacking banks ATM machines.
The Big Switch by Nicholas Carr is an excellent explanation of the next wave in computing. Basically computing power will be provided and thought of like electricity:
http://www.nicholasgcarr.com/bigswitch/
kailua,
Here is a good explanation:
http://en.wikipedia.org/wiki/Cloud_computing
dcmarciano and IBM is certainly a big player in this. IBM was basically already going this way (to services provided by their big servers) before it was even called cloud computing. Google is big too.
BTW Virtual Machines play a big role in this too. They allow for the companies that might have applications that they created or any other reason they can’t just run X application, instead they can say, give me X amount of machines.
dcmarciano, as for what problems this solves. When I first got into computers in the 1970s almost all computers were time shared. Then the personal computer took off and that “was the wave of the future”, to the point that Microsoft didn’t even allow for multiple users on a machine. Well this was great for individuals, but it wasn’t so great in lots of cases for businesses. Software had to be loaded on to hundreds if not thousands of machine, and maintained. And frankly the data is most likely not getting properly backed up. The business also finds it hard to control what employees do and put on the machines. Viruses are a constant problem. The first step is bringing back some of that time sharing model, by doing more and more on the company servers. But for lots of businesses they don’t want to worry about the computers, hackers and viruses, they just want it to work. And if you can do the job off of a machine in some server room, why not across town or across the world. So this is really an old/new idea. Where the “new” is really about the fact that the technology is getting to the point that the same “personal” experience can be provided from a larger machine that can be shared. The biggest flaw with the “personal” computer for a business is that you pay large sums of money for computers that mostly sit there not using their full potential.
BTW I should also mention how important the network is. I should have put it down as the second biggest concern. But if you compare the 99.9% up time of a large web service to the average IT department in a business that knows nothing about computers, you are still doing pretty good.
Another tangential play on this is internet traffic cop F5 Networks (FFIV). They have had a decent run up this year, but would be a candidate to buy on a dip. Full Disclosure: I own shares of FFIV.
Information security is important but it wasn’t very long ago that the majority was afraid to shop online.
IBM has applied cloud computing to solving resource intensive computational biology problems. I figured that would be an entry to investing in this movement. However, I have to say that I’m not sure what problem cloud computing solves.
Pardon my ignorance. But, what is “cloud computing”?
Jim,
Isn’t EMC a better way to play this area?
Christopher,
Thanks for the explanation; it makes sense a company would use cloud computing to focus on running their core business and eliminate IT section, but not sure most businesses would give up control of their info. Makes even more sense that a business would contract a company to run it in house for then. Then they could have their cake and eat it too, or should I say eliminate their IT section and have their records secured the way they want.
I am sure we all agree that cloud computing has limited application for businesses, for security reasons. But I think it could have some value for consumers, which could make it a good-sized niche in the tech sector.
Think about it: Why pay $50 or significantly more for some software package when you can get it via cloud computing for a few bucks, or even free? (with the software company making money via advertising)
While I don’t foresee cloud computing being “huge”, it should be reasonably profitable, although certainly not at the premium prices Jim quoted for some of those companies.
i completely agree with the security issue (i don’t use Gmail too much because i don’t get to keep my emails on my computer), but other factors to consider is that not everyone have fast reliable connection to the internet (sometime it is reliable and other time it is fast).
i realize that most developed economies have that but many less developed countries don’t.
I would never entrust my information to the cloud and if i were a business I would be terrified to do so. After all the information becomes the heart and soul of most companies. Never out source your heart or your soul. It reminds me of time share computing and that fizzled after relatively few years.
Of course this does not preclude people making decisions they later regret and causing cluod computing to have a run up until the bubble bursts.
Actually as I think of it. I should have given IBM and Oracle/Sun better billing. Both are major players in the top end servers(computers) and can combine their software expertise to provide a good hardware/software bang for the buck.
CISCO is certainly the major player for the network parts. Of course there is all the computers, for that I would think Dell and second HP.
“My question is who provides the picks and shovels for cloud computing. ”
Maybe not the picks and shovels, but perhaps the nuts and bolts are provided by cisco. Not sure though. Much cheaper than amazon.
Thanks Jim,
I didn’t even realize that Amazon was in this space. I personally wouldn’t pick any of the small players either. There are just to many very large players in this market. Like IBM, Oracle, Microsoft, Google.
pk3hi,
To answer your question I think all you have to do is look to all the outsourcing. Unless your business has some need that just can’t be provided by a generic provider, most companies would prefer to concentrate on their core business and farm out most of the IT and such to others. Besides if generic these big companies can provide the service at a cheaper price then it is done in house. This is true because a big company can share not only the actually machines, but support staff, and on top of that they get better prices on all their equipment.
The biggest road block for cloud computing isn’t price. The road blocks are if they need something very specialized, but even more important is the concern over security. And this security concern comes in from the fact that your data is not on company machines, and the transmitting of that data. While it is on your machines you know that what measures are being taken to back it up and protect it from attack. If it is on another companies machine you have to trust as much or more then you trust your own people. That is another reason I’m very leery of the small players. Trust is going to be a big factor what companies get who’s business.
My question is who provides the picks and shovels for cloud computing. It’s hard for me to understand why any company of scale would choose to outsource and not develope their own inhouse cloud. What service does SuccessFactors provide that Walmart can’t provide cheaper in house?