What is the cloud? Cloud computing could be best described as delivering computing, storage, and applications as a service over the Internet. It means that a company basically outsources its computer infrastructure to another party but can still access all its functionality through a smartphone, tablet, or PC. The main benefit of cloud computing is cost savings. These savings, which can be significant, are making the cloud increasingly attractive to large corporations and government agencies looking to cut expense.
The heart of the cloud is the platform, the setup and services available from the cloud provider. As more large companies become interested in the cloud, tech giants are increasingly pushing to get their platform considered. This burgeoning competition between industry leaders could significantly alter the economics of cloud computing and even total corporate tech spending, which may offer alert investors profitable opportunities.
Amazon's cloud success
Amazon.com (AMZN) has quietly become a leader in cloud computing. The company's offering, called AWS, was started to simply absorb excess capacity on its computing infrastructure but is now a popular platform choice. In 2012, AWS generated an estimated $2.0 billion in revenue, up from a $1.0 billion in 2011, and is expanding at around $200 to $300 million a quarter.
Still a small part of Amazon's total business, AWS has significant room to grow. Though the platform is most popular with tech startups and smaller firms, it’s looking to become more attractive to the large enterprise market. For instance, AWS recently launched a large-scale data warehouse service at an extremely competitive price. Amazon also noted that SAP Business Suite software, very popular with businesses, has been certified to run on the platform. But Amazon’s low cost selling point is its major advantage. AWS has lowered prices 31 times since it launched in 2006, including 7 price reductions so far in 2013, and it probably isn’t done. By leveraging its scale, Amazon can continue to hobble competitors with lower and lower pricing.
Tech giants want to catch up
Some tech giants have awoken to Amazon's lead. Microsoft (MSFT) understands the cloud represents a significant threat to its traditional business of selling software installed on individual machines. As a result, the company aims to compete directly with AWS for a meaningful place in the business.
Microsoft first offered its platform called Windows Azure a few years ago. Azure focused on large corporate clients and offered to rent applications like databases and servers for broadcasting video. These big enterprise customers are now starting to consider fully embracing the cloud.
Microsoft wants to keep them in the fold. It is making Azure more appealing to big businesses by expanding its international presence. The company recently announced a Chinese launch, the first time that international cloud services will be offered to businesses and consumers in China. It also announced a simultaneous cloud expansion in Japan and Australia, where it will set up new data centers. To maintain cost competitiveness, the firm has also committed to match Amazon's pricing.
Google (GOOG) is also getting more involved in the cloud. Attempting to build its reputation as an enterprise and developer-focused provider, the company recently made its Google Cloud Platform available. One of the platform’s advantages is its network speed. The data center connections are extremely fast. One reason is the company’s private distributed backbone between all the locations. This private network is much faster than the Internet, and the increased speed means lower customer pricing as more data can be processed in less time. To further lure the lucrative corporate client, the company has announced that its cloud service can be purchased with a new, lower-cost “Amazon-like” by-the-minute billing scheme. It has also announced that its Datastore product, an enterprise cloud data storage service, will have pricing reduced up to 25%.
Smaller players may be at risk
As tech behemoths wage war over the cloud, smaller firms such as Rackspace Hosting could be at risk. A provider with about $1.4 billion in sales, it is the co-founder of OpenStack, an open cloud platform. The company is focused on a high-end market segment that demands, and is willing to pay for, strong support and management services. These customers usually wish to build their own private clouds and then connect them to the public Internet-based cloud. OpenStack was developed around this idea. But as Amazon kept adding services, cutting prices, and gaining more customers, big corporations found public cloud exclusivity and its price advantage an enticing alternative. That, and Microsoft and Google aggressively entering the market, may soon put Rackspace under some intense pressure.
While the company reported good first quarter results - net revenue rose 20% year-over-year to $362 million and adjusted cash earnings came in at around $65.1 million, a 23% increase - there were a couple of warning signs. First, the rate of revenue growth has slowed significantly. This quarter’s 20% gain is the latest in a string of lower amounts over the past year. Second, the company also trades at a fairly optimistic valuation. Based on estimated annual sales of $1.75 billion and cash earnings of $277 million, Rackspace sports a P/E of roughly 20, which may be a little too enthusiastic given the level of competition it is likely to face.
Cloud computing is an increasingly attractive proposition for large companies and industry giants are aggressively competing over these lucrative customers. This fight could have a significant effect on smaller cloud players and tech spending in general. While the clash over the cloud is likely to be very disruptive to those involved, it may also offer astute tech investors some nice, profitable opportunities.