Everything is cloud computing! What does that mean?
Cloud computing is a network of servers on the Internet that store and process data remotely. In simpler terms, the cloud is the Internet. The cloud has grown so much in the past five years that knowingly or not we have all become a part of it. The cloud is made up of three components Software, Platform and Infrastructure.
Cloud Software are applications that are directly accessed by the end user, that’s us. Software in the cloud will replace the need to download applications onto your computer or mobile devices. The applications that stem from Software as a Service are numerous and growing daily. Some of the more popular examples of this is Facebook, Twitter and Gmail. Software is the most accessible level of cloud computing; this is why it is already the largest revenue producer within the cloud.
The next part of the cloud is called Platform, or middleware. Platform as a Service provides the tools needed to create online applications and websites. This portion of the cloud is less well known because it is used mostly by software and application developers. Google has a platform called the Google App Engine that allows people to create and share their own application, of course to use this program requires programming skill and know how.
The last and largest part of the cloud is the Infrastructure. This is the foundation upon which the cloud ecosystem is housed. Infrastructure consists of the vast server warehouses that contain the network, data and processing performed by the cloud.
Hopefully, these descriptions yet to lose you.
At this point you might be wondering why to invest in the Cloud. The answer is as simple as it is powerful, all computing is moving into the Cloud. Just as the PC quickly paved the way for unprecedented connection between people. Cloud computing has already enhanced this connection… not just between people but also between every device.
Virtually all data has already been moved to the cloud on the tool known as the Internet.
The next step will be the hardware transition. Computing will progress to where all that will be needed to access the cloud will be a screen and an internet connection.
The final step to Cloud domination will be the human resource transition, outsourcing human labor to the cloud, as a major disruption in the tech community is already in the works, referred to as the 3rd Platform.
The 3rd Platform consists of the disruptive technological innovations of Big Data Analytics, Mobile, Social Business and the Cloud. 75% of IT growth within the next 5 years will be within the 3rd Platform, a total of $5.3 trillion, by 2020. The Cloud is the foundation on which this 3rd platform is set to take place.
Cloud revenue is growing at a compound annual growth rate of 28% broken into sectors software has an annual growth rate of 35%, Infrastructure 29% and Platform 13%. The most growth opportunities clearly lie within software and infrastructure.
Zendesk (NYSE: ZEN)
The first company in Cloud 4 operates solely in the Software Sector, Zendesk. Zendesk offers a wide variety of cloud based applications that are created specifically for decreasing operating costs for businesses. Zendesk’s offerings include sales, marketing and human resource applications that replace the need for businesses to employ many different departments, they can outsource this work to the cloud. They also use a cloud based artificial intelligence and data analytics to identify opportunities for customer service improvement and cost reduction.
Zendesk first went public in 2014, and since then they have been able to grow their revenue by 388%. To put this in perspective, the rest of the IT industry has grown by only 80% over the same period. Zendesk is subscription based so they are able to produce a steady revenue stream year after year.
An average annualized revenue growth rate of 63% was estimated based on historical growth and pro forma estimates. To calculate their operating expense growth, I analyzed the two main expenses: Selling & Marketing, and Research & Development, their individual growth rates were 57% and 62%, respectively.
To value this company, a price to sales model was used and this estimated a price to sales multiple of 6, equivalent companies are selling at a price to sales of 10 and this returned a fair value of $45, a 39% undervaluation.
Salesforce (NASD: CRM)
Salesforce has exposure to two cloud sectors: platform and software and is actually the founder of the SaaS industry and was the first company to deliver a scalable cloud computing platform. Salesforce developed early in the formation of the cloud, and as such hold the most market share of any company that operates solely in the cloud, 5%. Salesforce is the leading cloud provider of customer relationship management software. CRM is a broad range of business applications that replace the need for costly departments, like Zendesk they enable businesses to outsource labor to the cloud.
As far as salesforces financials are concerned they have fared well in the past 8 years averaging 24% over this time in organic growth. Salesforce has acquired many smaller cloud companies which contributed an additional 10% to their topline revenue.
Interestingly enough, when the 2008 financial crisis occurred most companies took a large revenue hit, Salesforce actually grew by 50%. These gains can be attributed to the cost reductions businesses experience when outsourcing to the cloud. For the past ten years Salesforce has also been steadily increasing their cash flows at a compound annual growth rate of 129%.
So to value Salesforce I used two models, free cash flow model and price to book model. The total free cash flow model returned a fair value of $87.82 an undervaluation of 20% The price to book model returned a fair value of $94.09, an undervaluation of 21%.
Next we have a well-known company that operates in every sector of the cloud, Software, Platform, and Infrastructure, Oracle. Oracle is a large data-basing and software production company. The second largest software producer behind Microsoft. They offer a wide variety of software, systems and cloud models. Oracle is the only company in Cloud 4 that does not generate the majority of its revenue from the cloud, 23% currently. Oracle’s cloud business is expanding and growing by 20% annually as a percentage of total revenue.
Oracle’s growth rate came from several sources: historical rates, management and analyst estimates and personal estimates and this returned a weighted growth rate of 9.4%. However, Oracle Cloud revenue has grown at an average rate of 66% year over year. This rate is expected to increase to 80% by the first quarter of 2017. So different growth rates were applied to their two revenue streams Software 11.3% and hardware -8.5%, as a result of increasing software sales and decreasing hardware sales. As Oracle increases their cloud exposure this software revenue will increase at a proportional rate.
Oracle (NYSE: ORCL)
Oracle operates in every sector of the cloud, Software, Platform, and Infrastructure. It is a large data-basing and software production company. The second largest software producer behind Microsoft. Oracle offers a wide variety of software, systems and cloud models,
Oracle is the only company in Cloud 4 that does not generate the majority of its revenue from the cloud, 23% currently. Oracle’s cloud business is expanding and growing by 20% annually as a percentage of total revenue.
To find Oracle’s growth rate I took historical rates, management and analyst estimates and my own estimates and I calculated a weighted growth rate of 9.4%. However, Oracle Cloud revenue has grown at an average rate of 66% year over year. This rate is expected to increase to 80% by the first quarter of 2017. So I applied different growth rates to their two revenue streams Software 11.3% and hardware -8.5%, as a result of increasing software sales and decreasing hardware sales. As Oracle increases their cloud exposure this software revenue will increase at a similar rate.
Rackspace (NYSE: RAX)
The final company in Cloud 4, Rackspace, is a large cloud Infrastructure and Platform company. Rackspace, like other cloud companies provide instant access, massive scalability and utility-style bills. But what sets them apart from the rest is their hosting program that allows the user to combine their cloud spaces and services from every cloud provider including the market leaders into one platform.
To select the stocks to put in Cloud 4, there were several selection criteria. They needed to be positioned in every part of the cloud stack, the index had to have exposure to every sector of the cloud and the securities’ revenues need to correlate with the overall growth of the Cloud Industry. An underlying reason for this selection, is the likelihood for the stocks to be acquired.
As you may have noticed Rackspace’s financials were not discussed, this was no accident.
Rackspace has been around since 1998, that’s 18 years! Since the creation of Cloud 4 in late August 2016, Rackspace has been acquired, at a 39% premium by private equity group Apollo. This validates my investment rationale and shows that these companies are prime acquisition targets.
Currently, there are massive cloud formations in the works, the cloud is profitable in a recession, the cloud is everywhere and as cliché as it may sound, and the cloud is the future.