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In Which Cloud Provider Should I Invest?

- By Sangara Narayanan

The cloud industry has gone through a period of massive growth in the last five years, but it has still barely scratched the surface of the market's potential.

Top cloud companies Amazon (AMZN), Microsoft (MSFT) and IBM (IBM) have barely crossed $10 billion each in revenue from their cloud solutions, and the traditional IT infrastructure spending still accounts for the bulk of overall spending.


Over the next five years, the cloud infrastructure industry is expected to grow at a CAGR of 12.5% and should hit nearly $60 billion by 2020. But even at that level, it is less than half of enterprise spending on IT infrastructure. Of that, public cloud is expected to bring in $37.5 billion while private cloud solutions will account for a little over $20 billion annually.

That might not sound like a huge figure, but we're only talking about the basic cloud platform. We also need to consider Software-as-a-Service and Platform-as-a-Service revenues; it is there that we will see long-term, sustainable growth for cloud providers.

Based on the types of cloud solutions offered, the cloud market can effectively be split into two camps. In the first are companies like Salesforce.com (CRM) and Twilio (TWLO), whose primary focus is on SaaS and PaaS. In the second - the more discussed one - are companies that offer a full stack of cloud services from infrastructure to development platforms to software to migration and cloud infrastructure management solutions.

It is this second group that is leading the growth in cloud. Its basic IaaS offering is complemented by a host of SaaS applications, and typically a cloud development platform so companies can create their own cloud applications. In addition, several ancillary services are provided, such as data movement and infrastructure management.

Microsoft's model uses Azure on the IaaS side, but if you have been following the company you may have noticed that Office 365, Microsoft Dynamics and other, newer SaaS applications such as Microsoft Teams are actually hogging the limelight. By offering a full stack of cloud applications that address not only infrastructure needs but also productivity, business process management, customer lifecycle, collaboration and other areas, Microsoft is becoming indispensable to the enterprise companies it serves.

Amazon, on the other hand, has kept a laserlike focus on the infrastructure side of things, and it shows in its revenues as well as market position. It has cut its cloud pricing more than 50 times since AWS was officially launched, and it has the margins to keep it up whenever required. That strategy has resulted in consistent growth of over 50% quarter after quarter. When a company is cutting costs but still able to post strong margin numbers, it is a clear indication that the product lineup is growing, and that's exactly what has kept Amazon at the top of the cloud industry for such a long time. The pace at which Amazon keeps improving its existing products and releasing new services for its users is breathtaking, and this DNA will keep Amazon at the top for a very long time despite the competition.

IBM is the darkhorse, with its Analytics unit doing a lot better than many people realize. The company is big, and hence the transition from legacy to cloud has been extremely slow and painful. But, somehow, IBM has been able to keep up the pace with the new age competitors, growing their cloud as-a-Service run rate from $5.4 billion in the first quarter to $7.5 billion during the third quarter. But unless investors notice the top line moving in a stable growth path, the valuation will remain depressed.

Google, Oracle (ORCL) and all other small cloud providers have a long and winding road to the top. Oracle's strength in databases is a key to its cloud future, but it is way behind the curve, and the company needs to do a lot more work to even get close to where Amazon and Microsoft are in the infrastructure business. Google has been taking the partnership route in its climb to the top, and its biggest headache is its own need for infrastructure, which keeps growing at a rapid pace. But with billions of dollars in cash on hand, Google has the ability to pull it off. Its recent partnership with Intel (INTC) will help them along that path, as will the chip-maker's own position in the data center segment.

The question of who to invest in based on its cloud growth is an easy one to answer. Get a piece of all the major players. It's still too early for cloud revenues to make a dent in their overall incomes, but for every company that's in the game, it means longevity. The fact that they are cloud service providers means that growth will be sustained at least for the next five years, most likely well beyond that. You could invest in an ETF like SKYY, but that means accepting the bad with the good.

Rather, look for opportunities to invest in at least three major cloud players, which are basically Amazon, Microsoft and IBM as of now. Oracle and Google will take their time growing to scale, but these three have gone beyond the point of no return, as they say. They are committed to growing their cloud businesses as quickly and strongly as possible, and those are the stocks that need to be in your portfolio.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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This article first appeared on GuruFocus.