The Cloud Is Coming Alive

Rob DeFrancesco Founder, Tech-Stock Prospector

The cloud is the new dot.com frenzy where earnings are immaterial, as old line software companies are moving in and the cloud pioneers are expanding their market share in the hopes of becoming a big fish or being swallowed by one, says Rob DeFrancesco of Tech Stock Prospector.

Gregg Early: I am here with Rob DeFrancesco, editor of Tech Stock Prospector. Rob, I think one of the big topics today that a lot of investors are hearing about-but I'm not quite sure how much we understand it-is the cloud. Could you talk to us a bit about the cloud, what it means, and who's going to benefit out of all this?

Rob DeFrancesco: Sure, the cloud, that term, is fairly new. We've heard of it as described as on-demand software, but basically, instead of buying packaged software or instead of buying a huge software package, enterprises are accessing software via the cloud. They are accessing it from outside of their premises. I think it's a major change going on in the industry right now.

You have your old legacy software companies, Oracle (ORCL), Adobe (ADBE), Autodesk (ADSK), and then the big cloud company these days is Salesforce.com (CRM). Earlier this week, Salesforce kicked off its Extreme Force User conference with 90,000 registered attendees, which shows you how big this is.

It was funny, because then also yesterday Adobe-which is an old school software company-had their earnings report and virtually the entire call was about how they're moving their product to the cloud. They have a thing called Creative Cloud, and they're getting 25% of their revenue now from recurring as opposed to just selling a software package up front.

The good thing with a cloud company is you get a steady stream where people are paying you either yearly or monthly for the service. It provides for these companies where it is like they are looking at forecasting earnings every quarter, and so this gives them a better insight into what their business looks like down the road. So it smoothes things out a little bit.

Gregg Early: It's more reliable than, say, with the software model. If you buy a piece of software, you don't know whether next month you're going to sell the same amount of software. Whereas now with the cloud, you are evening that out so that you have subscriptions. Salesforce.com has been a pioneer in this right? They've been around for a long time.

Rob DeFrancesco: I think CEO Marc Benioff is smart. He's like an evangelist for this software, and watching him talk, he's just so excited about it. Obviously he has an interest in it, and they're doing extremely well.

I think they're past $3 billion in revenue right now, so they're not huge compared to Oracle. I just saw something where some analyst said that he could see them getting up to $10 billion. They have everything in place for the next several years for reaching that level.

Salesforce is the biggest cloud player out there. I think their market cap is around $20 billion, so they're the leader in terms of market cap. But over the past, say, 12 to 24 months, we saw a lot of large, older software companies buying up the cloud.

SAP bought Success Factors, which was a cloud-based software company that does human capital management. They are basically doing on-boarding and recruiting and things like that. Then Oracle bought Taleo, IBM bought Kenexa, SAP also bought Ariba, so these cloud companies that have been around for a little while, are getting bought up, and there's been a whole new crop of recent IPOs that have come on board.

There's a lot of cloud-based companies now that are public out there. A lot of times with these smaller companies, you have to be careful because they come out with these huge valuations because they're showing great revenue growth. And inevitably they stumble, or something happens-they have a bad quarter-and they come down, and that's often an opportunity to get in there.

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I just ran a screen of a bunch of what I call "next-generation software stocks". You have some of them trading at 20 times forward revenue, which is just a little out of control. You can love the company, but not that type of valuations for these. They have a lot of promise. It is often better to let them mature for a few quarters and then take a look at them again.

Gregg Early: So you like sticking with some of the older ones that are more established. How is Amazon (AMZN) in this field? I've heard Bezos and others talk about the fact that they've had to have so many servers that having the cloud was something that just came naturally to them. Is that a big part of their business, or is that a cloud-based company conceptually?

Rob DeFrancesco: Amazon has a unit called Web Services, where they actually are the infrastructure of, let's say, behind the cloud. But their core business is still just basically online retailers.

They're sort of involved in this as well. That's another one...some of these stocks are what I call battleground stocks, where you know if you look at Amazon, the valuation is out of control, just what some people have said about Salesforce.

A lot of these companies are in hyper-growth mode. They're not really concerned as much about the bottom line. They are trying to grow the business, grab share...and with Salesforce for example, there's been a lot of recent acquisitions that have diluted the bottom line, but they're building off the revenue-it's still growing say 30% a year-and they're building up a business.

Recently, the Salesforce CFO said that they are not telegraphing that they are concerned about the margins right now. They're in growth mode, and that's where their focus is.

So going back to Amazon, that's the complaint with that stock as well. It's sitting here, it has a $117 billion market cap and they are taking a lot of business away from just regular retailers, so that is their growth story. The cloud for them-obviously they're a cloud company, but it's a smaller part the business.

Gregg Early: Well, are there a few stocks in particular that you like in this space?

Rob DeFrancesco: Yeah, there's.the problem I'm having is a lot of these companies since the spring have really done well.

There is a company called Cornerstone On-Demand (CSOD). It's gotten a boost; it's up to $30 now, but I started recommending it around $20. They're in the cloud- human capital management-and it's gotten a boost because everyone thinks somebody will take it over.

That's the problem, we're at a level now where I question a lot of these big cloud names. NetSuite (N) is another big one that does enterprise resource planning. They basically are doing payroll and back-office type of financial stuff in the cloud.

There is a company called Jive Software (JIVE), and that does enterprise collaboration. Basically, a lot of these companies have similar products.

Salesforce has Chatter and Microsoft just bought Yammer for about $1.2 billion and Jive is a smaller competitor and IBM is also in this. It's basically collaborating enterprise, people can share, and it's almost like Twitter for the enterprise, where you can share informational sales, leads, or what's going on with the company.

Jive is interesting. It went public and the stock ran up to close to $30, and then it did settle back down to the low teens and now it's around $16. I think it's a promising company. They have a good management team, and that's one I think it's not the valuation isn't so high and it's attractive.

I think as the market comes back, a lot of these cloud names, they are companies that I would be interested in looking at. But right now, a lot of the stuff is extended.

Gregg Early: It sounds kind of like when the .com revolution was going on, you had the big players and then you had all these potentially little players that someone was going to buy. Everything's at a premium, and nobody really cares to a certain extent, because it's just everybody's grabbing whatever they possibly can.

Rob DeFrancesco: True.

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