For the uninitiated, cloud computing can be a daunting subject. For investors, it’s a nightmare. ETFs like First Trust ISE Cloud Computing Index Fund (SKYY, Financial) do a good job of aggregating the best stocks in this segment, but as with any ETF you tend to get a lot of chaff with the wheat.
This article showcases the three largest cloud providers in the world and highlights why they will remain at the top for the foreseeable future.
What is cloud computing?
In its simplest form, the cloud is merely virtual real estate space for data. As businesses started to move away from keeping manual records to “computerizing” themselves, they needed increasingly large amounts of hardware and a host of software applications to keep the engine running. In addition, they had to invest in networking solutions and other add-ons that made them more efficient.
But that efficiency came at a cost, and the cost was so high that IT soon became the largest expense item for most companies.
Enter Cloud Infrastructure-as-a-Service (IaaS), where providers with extra rack space offered storage, accessibility and control via the Internet. Businesses could now offload their expenses by switching to the cloud and paying a monthly or annual fee for using such services instead of investing thousands of dollars on equipment, software and skilled manpower.
Cloud segments
Within the gamut of cloud services are three core components: Infrastructure-as-a-Service, Software-as-a-Service and Platform-as-a-Service. IaaS, SaaS and PaaS, as they’re referred to, make up the bulk of cloud services provided around the world today. As I mentioned, IaaS involves providing virtual server space; SaaS is essentially any software that can be accessed through an online login rather than having to be downloaded into your local system or network, and PaaS is a virtual platform on which users can develop and run web applications.
Nearly all of us use the cloud in one way or another. Do you have a Gmail account? Every time you log in to check your email, you’re using Google’s most famous SaaS application. Facebook (FB, Financial), Twitter (TWTR, Financial), YouTube are software applications that can be accessed on their respective servers via the Internet using a username, email ID and password.
There are also specialized cloud services such as Business Process as a Service, Database as a Service and even Analytics as a Service.
The first cloud providers
Among the larger companies in this space, Amazon (AMZN, Financial) was the first to step up to the plate with its Amazon Web Services (AWS) division. In short, the ecommerce giant took all the excess space on its servers, created virtual servers and started renting them out for a monthly fee. Conceptualized in 2003, AWS first rolled out its service to the public in 2006, when it immediately became a mass hit with developers.
Once AWS started to gain traction, other cloud players like IBM (IBM, Financial), Microsoft (MSFT, Financial), Google, Rackspace (RAX, Financial), Oracle (ORCL, Financial) and a bevy of companies jumped on the bandwagon. Today, the entire cloud industry is estimated at $110 billion and growing at a rapid 28% year over year.
Amazon Web Services
As of the most recent quarterly earnings report, AWS revenues touched $2.57 billion, giving it a clear runway to meet and beat $10 billion in revenues for the 2016 fiscal. The group is also infinitely more profitable than Amazon’s entire retail business and brought in an operating income of $604 million on the $2.57 billion gross revenue. That gives it an operating margin of 23.5%, one of the highest in the industry.
That kind of margin allows AWS to be extremely aggressive on pricing, and so far it's reduced pricing no less than 51 times. That’s what gives it the edge over smaller providers and, to an extent, over major competitors like IBM, Microsoft and even Google.
Last year, Amazon finally crossed the $100 billion annual revenue mark, but continues to struggle in terms of profitability. Despite the success of Prime and the introduction of several new products over the past year (Kindle Fire, Echo, etc.), AWS currently stands as the highest net income earner for the company.
From a trailing 12 months perspective, AWS revenues currently stand at $8.92 billion.
IBM
IBM is a seasoned player in the cloud, but it was only in the past four years that it's really pushed the cloud agenda – after Ginni Rometty took over the helm as CEO in early 2012. Cloud computing is one of her strategic imperatives, and IBM is already making waves as the largest provider of hybrid cloud solutions in the world.
IBM has an edge over AWS and most other companies in that it has existing relationships with most of the world’s largest corporations, and converting them to the on-premise hybrid model has been its strength so far. In addition, IBM also has the popular Bluemix platform with well over a million developers on board, as well as SoftLayer, the IaaS component of its business.
This past quarter, IBM reported cloud revenues of $10.8 billion on a TTM basis, putting it ahead of AWS’s $8.92 billion.
With the lead that IBM currently has over Amazon, the company is pushing its cloud agenda in several ways, the foremost being hybrid cloud infrastructure and Watson’s cognitive solutions and predictive analytics delivered as a service.
At 1.9% growth rate for its Technology Services and Cloud Platforms on a constant currency basis, IBM’s growth isn’t lightning fast, but it has managed to take it not only to the No. 1 position in hybrid cloud solutions, but even rival AWS’s dominant position in cloud infrastructure.
And that brings us to the third major cloud provider.
Microsoft
Microsoft’s most recent claim to cloud fame is its Office 365 offering, which is essentially a SaaS application. Zooming past Google Apps, Box (BOX, Financial) and Salesforce.com (CRM, Financial), Office 365 is now the world’s most popular productivity software offered on the cloud.
Unfortunately, Microsoft doesn’t break out its earnings in quite the way we’d like; however, a little digging into its numbers reveals a healthy growth rate of 120%+ for Microsoft Azure, its infrastructure offering, and an annualized run rate of $10 billion as of third quarter 2016.
Now, back-calculating the TTM revenue from the run rates for the past four quarters, we arrive at $8.9 billion – slightly below AWS.
Office 365 is currently the star of Microsoft’s cloud lineup, and with Azure boasting three-digit growth and Azure Stack now focused on enterprise clients’ hybrid needs, the cloud segment looks like a promising growth driver for Satya Nadella’s new Microsoft.
No Google?
I deliberately haven’t included Google in this list of major cloud players because the company has been late to the cloud race despite owning the technology for several years now. It was only at the beginning of this decade that Google launched its GCP (Google Cloud Platform), and it has a long way to go in terms of revenues. At the end of the last fiscal, Google cloud revenues were still a ways from hitting $1 billion. In a race where $3 billion per quarter is the new black, Google is still far behind.
To its credit, however, it's moved board member Diane Greene to head the cloud division and she’s been bringing in some big-ticket clients such as Home Depot (HD, Financial). But even with Google’s aggressive pricing plans, they need more than a few big names to realistically compete against the constantly moving targets that are Amazon, Microsoft and IBM.
The investment angle
From an investment perspective, don’t think about investing in a single company. Think about this as an industry with three big players as of today. Invest in all of them equally – Amazon, IBM and Microsoft – so your portfolio has both strength and balance within the cloud industry. As one company takes the lead, invest more in that stock so you’re always ahead of the game.
The biggest benefit of doing this is that every other initiative undertaken by these three giants of cloud will be added on as an upside to the stock you own. You’re investing for the cloud, but you’re getting the whole package – Echo, Watson, Windows 10 and every other major project they get into.
Disclosure: I/we have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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