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Cloud computing is the future--here's how to buy a piece at a reasonable price
06/14/2010 7:37 pm EST
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.
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