The cloud computing industry has been on what appears to be a never-ending growth spree. As an analyst, whenever I look at any hyper growth company or sector, I always think about the next phase of growth because, most of the time, the stock tends to be "overheated" when companies keep posting double-digit growth numbers.
Thankfully for the top cloud service providers - Amazon (AMZN, Financial), Microsoft (MSFT, Financial) and IBM (IBM, Financial) - cloud is not the only thing they do. But cloud represents one of the most important things these companies do. The combination of this and the fact that their core businesses have been around for a long time allows them to trade at reasonable and even attractive valuation multiples.
The presence of this trio at the top of the cloud computing world has another positive angle to it —Â the fact that they keep pushing each other deeper into innovation. Each has found its strong suits in the cloud, and each already dominates or is very close to dominating its own niche. There is enough of an overlap between their capabilities to help them motivate each other to greater heights.
As such, their growth in terms of cloud-related revenues have been growing at impressive rates for the past two years, often exceeding 50% year over year growth in a given quarter. But there are two crucial factors driving this growth.
First, the Infrastructure-as-a-Service segment is still small. It is worth tens of billions of dollars, yet is still quite small.
As of 2016, the IaaS market reached $22 billion, and even that was a 38% increase over the year before. Over the next five years, IDC estimates that the IaaS segment will grow at a CAGR of 28.2% to reach $43.6 billion by 2020.
To get another perspective on the cloud computing industry, let’s look at worldwide data center spending using an analysis from Gartner:
Global spending on data center systems has been over $170 billion for the past two years. The bulk of this is likely to have come from cloud service providers themselves, judging by their own growth rates. If data center investments can run into the hundreds of billions, there’s clearly ample room for IaaS growth, very possibly in strong double-digit rates for the next several years.
Second, the cloud computing leaders in the IaaS space are growing their revenues year-over-year. That’s always a good sign of long-term growth.
Posting double-digit year over year growth is impressive enough, but posting sequential growth is even better. All three cloud service providers are seeing sequential growth in their respective cloud revenue numbers.
- Microsoft’s annualized commercial cloud revenue run rate increased from $13 billion at the end of the first quarter 2017 to $14 billion by the end of the second quarter.
- Amazon Web Services revenue grew from $3.231 billion in the third quarter 2016 to $3.536 billion in the fourth quarter.
- IBM’s cloud as-a-service run rate increased from $7.5 billion at the end of the third quarter 2016 to $8.6 billion by the end of fourth quarter.
That kind of a sequential increase is a very clear indication that growth momentum in this segment is too high to suddenly show a slowdown over the next few years. Moreover, we’ve already seen that industry experts are tracking exactly that kind of momentum over the period.
These three companies are leading the disruption bandwagon, with Google (GOOG, Financial) (GOOGL, Financial) now embracing Microsoft’s products for their cloud platform and Oracle (ORCL, Financial) crossing the $1 billion mark in total cloud revenues for the first time. IaaS is not the strong suit of either Google or Oracle. Alphabet is not even reporting standalone numbers for cloud, but we expect it to start once it hits the billion dollar level per quarter. As for Oracle, both sequential and year over year IaaS growth were relatively flat, but the company only recently started its IaaS journey.
Investors must keep their eyes on these five companies and their progress in cloud. There is unseen upside, but because cloud is not yet their core business, it makes their valuations more justifiable.
Disclosure: I have no positions in the stocks mentioned above and no intention to initiate a position in the next 72 hours.
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