Technology goes through generational shifts: Mainframes. Minicomputers. Personal computers. The internet. Now, cloud computing.
In each era, there are winners and losers. The names change, as some companies can’t make it across the next chasm, and other companies take their place.
As an investor, it makes sense to have a hand in the mainstream technology of your time, and in this decade that means investing in cloud computing.
The cloud computing era began a decade ago, with the development of Google from Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL); the launch of Amazon Web Services from Amazon.com Inc. (NASDAQ:AMZN), a giant cloud computing cluster you could rent; and the launch of the Apple Inc. (NASDAQ:AAPL) iPhone, which transformed the PC paradigm, creating a supercomputer you could hold in your hand to access clouds. Of course, these companies are large enough, with diversified-enough revenues, to not be considered “pure plays” in the cloud, but they’re incredibly relevant for their ever-growing cloud operations.
What it takes to compete in cloud, first, is capital. A billion dollar per quarter capital budget is just the ante in this poker game. That means a cloud player needs cash flow, enough to sustain a massive capital spend, to profit directly from that spend and then to get through the period before service revenues make it all worthwhile.
All the companies on this list have this, plus one more thing, entrepreneurial CEOs with the power to forego current profit, invest in their clouds and focus on return only after the investment has been made, ignoring Wall Street demands to make a quick buck.
Thus, it should be no surprise that most of these companies are run by their founding entrepreneurs, and that none of them are corporate democracies, but dictatorships where the man at the top of the tower has firm control over the corporate destiny.
Best Cloud Computing Stocks: Alphabet Inc (GOOG, GOOGL)
CEO: Larry Page
Cash Flow: $28.9B
The cloud, as we know it, combines a group of technologies the company formerly known as Google found it needed to scale the search service launched by co-founder (and CEO) Larry Page and Sergey Brin in 1998.
Innovations such as virtualization, distributed computing and open source were all developed during the 2000s so that Google could scale its search, mail, video, mapping and commerce services to a global scale. As Google invested billions of dollars every year in its new data centers, then moved to develop Android so it could get even more traffic into those servers, the cloud was born.
Google’s cloud and advertising system created enormous value for investors. If you were fortunate to get in on the Google initial public offering, at $85/share in 2004, you now have twice as many shares as you bought, and each is worth about $800. Today, Alphabet Inc is the second most-valuable company in the world, at almost $550 billion, with minimal debt and over $78 billion of cash, much of it stashed overseas.
What’s most amazing in this story is just how many other opportunities Alphabet missed, ignored, or just let slip through its fingers along the way. It was late to renting that cloud capacity. It has done very little in commerce. Many of its services, like Google News, still run ad-free. And of course there are its “other bets” — ideas like self-driving cars, fiber infrastructure, walking robots, intelligent thermostats and life sciences research — which lost $802 million in just the last quarter, a figure analysts thought was pretty low.
Discipline is just one reason investors pay 30 times earnings for GOOG stock. The other is growth at scale, with revenues rising 15% per year, operating margins of 25% and operating cash flow of $26 billion last year alone.
Best Cloud Computing Stocks: Amazon.com, Inc. (AMZN)
CEO: Jeff Bezos
Cash Flow: $12.73B
Like Google, Amazon CEO Jeff Bezos built his cloud to scale an existing business, Amazon.com. Bezos’ innovation was to rent that computing capacity, just as he was renting fulfillment capacity and warehouse space, under the name Amazon Web Services, launched in 2006.
Where people saw an online bookstore, founded in 1994, Bezos saw the opportunity to create a global e-commerce infrastructure company, with its own warehouses, delivery systems, and back-end computing systems. To meet these capital requirements, Bezos began renting his infrastructure in 2006.
But Amazon didn’t just rent warehouses. Amazon also rented its cloud computers, using the cash flow to sustain enormous capital budgets which now average over $1 billion every quarter.
For many years, Amazon’s reinvestment meant it showed little or no net income. Then Amazon broke out AWS sales and profits on its income statement. Since the start of 2015, AMZN stock is up about 150%! Investors now realize Amazon is a leader in computing infrastructure, billing over $8 billion each year and earning margins of 28%.
As a result, Amazon is in the enviable business of being able to compete with its own customers. Netflix, Inc. (NASDAQ:NFLX) runs on Amazon Web Services but competes with Amazon Prime Video, which costs $9 per month against $10 a month for Netflix. The company is also expanding globally, with servers in over 10 countries, and a big push to dominate India’s fledgling e-commerce space.
Amazon has also become a device company, one whose devices tie people ever-more closely to the store. Its Fire Phone was a flop, but its Fire line of tablets and Kindle line of e-book readers both sell well.
The result is a juggernaut, with sales of $107 billion last year that should easily top $125 billion this year, growing profits, and a market cap of $365 billion, up 46% over the last year. Debt levels are falling, and the company had over $10 billion in operating cash flow last year.
Not bad for a book shop.
Best Cloud Computing Stocks: Facebook Inc (FB)
CEO: Mark Zuckerberg
Cash Flow: $11.2B
When Facebook Inc (NASDAQ:FB) was founded in 2004, the headline was the age of founder Mark Zuckerberg, 19. He was compared, sometimes facetiously, with Bill Gates, who also dropped out of Harvard at age 19 to co-found Microsoft.
No one is laughing now. What separated Zuckerberg, now 32, from his peers was his ability to see the future of technology and his willingness to make big bets based on that vision.
The most important bet came in 2009 when Zuckerberg, recognizing the power of cloud, decided he needed to be independent of Amazon and build a better, more efficient cloud he could invest in. The result was the Open Compute Project, a collection of shared designs that was cheaper to run and build than any cloud before it. Open Compute made the cloud affordable for Facebook, which had an asset base of under $15 billion in 2011.
Facebook does not yet rent out its cloud capacity. It’s growing too fast for that. Revenues tripled from 2012 to 2015, to almost $18 billion, and margins are climbing past 25%. Despite its capital budget, now averaging over $1 billion per quarter, it remains debt free.
Growth has allowed Facebook to become a very hungry acquirer, which it has been since buying AboutFace in 2005. Some of the companies Facebook has bought disappeared inside the company, some were acqui-hires meant to gain talent, but some have been home runs like Instagram, the photo sharing site that cost $1 billion in 2012, and Whatsapp, the instant messaging platform that cost $19 billion in 2014.
From a standing start 12 years ago, Zuckerberg has made Facebook a blue-chip investment and made himself the world’s sixth-richest man, with a fortune of over $50 million, most of which he has promised to eventually donate to charity.
Even Bill Gates’ life didn’t move that fast.
Best Cloud Computing Stocks: Microsoft Corporation (MSFT)
CEO: Satya Nadella
Cash Flow: $33.3B
A few years ago Microsoft Corporation (NASDAQ:MSFT), the company co-founded by Bill Gates in 1975, at the dawn of the personal computer era, would never had made this list. It was an applications company, tied to a dying platform and going nowhere.
Then Gates’ long-time number two, Steve Ballmer, decided to retire after nearly 14 years of stagnation. Immediately, the stock price began going up. After months of suspense, Microsoft found its second great entrepreneur, and its second wind, within its own ranks.
Satya Nadella, formerly executive vice president of the company’s cloud and enterprise group, has supervised a complete transformation of the company, from a staid software outfit to a cloud-first enterprise giant. Nadella did it by first increasing the company’s capital budget, almost $1.4 billion during the first quarter of 2016 , investing it in a network of cloud computing data centers under the brand name Azure.
Azure now has 26 data centers around the globe, serving China through a company called Vianet, with plans to add eight more. It now offers all its software through Azure, rather than through stores, and actually rents it to deliver more stable revenue and allow for instant updating.
The new version of its flagship operating system, Windows 10, will be the last, with updates now being done automatically. Its Office suite is now Office 365, also offered online, and with a storage system called OneDrive. Microsoft may be the only company in the world working to innovate around the PC with its Surface line and it has the capacity to work with global clients such as Boeing Co (NYSE:BA).
Nadella has made Microsoft a player at the leading edge of technology again, becoming a cloud applications superpower able to claim a solid number two position (behind Amazon) in cloud infrastructure rentals, and positioned to take on the newest flock of database-driven application companies, such as Salesforce.com, inc. (NYSE:CRM). It’s a buy now, not a sell, because Nadella was given the freedom to spend big money in the cloud, in cloud applications and in cloud services.
Best Cloud Computing Stocks: Apple Inc. (AAPL)
CEO: Tim Cook
Cash Flow: $63.2B
As recently as last year the world’s biggest company, Apple Inc., would not have been in a story about cloud leaders.
But as sales of the iPhone and iPad slowed, CEO Tim Cook began spending heavily on cloud data centers. The company’s capex budget for 2016 was an eye-popping $15 billion, some $4 billion of it going into data centers that will, in time, make it independent of Google and Amazon.
Just this year Apple began building 2.5 million square feet of data center capacity, much of it in existing facilities like Reno, against 6.7 million square feet for Amazon. More important, Apple justified that investment by delivering almost $6 billion in service revenue during its March quarter alone.
This is the key to making a cloud superpower. You need enough revenue and cash flow from other parts of the business to afford the investment, and in time that investment must become self-sustaining. Apple delivered the investment last year, and it is making that investment self-sustaining this year. Service revenue was up 19% year-over-year in the most recent quarter.
Apple has managed to do what even Google has not, create a steady revenue flow from apps and other content that is bought after the purchase of the device. While most Android users base their experience on free apps, Apple sells apps from most software publishers, and takes a 30% cut on those sales. For subscriptions, which it is now pushing, it takes a smaller but still substantial cut of 15%.
Apple also sells iCloud storage services directly, at prices up to $10/month in the U.S. for 1 Terabyte, which is now the size of many average hard drives. It’s a storage limit easily exceeded by a family’s collection of music and photos, let alone videos, meaning there is plenty of growth ahead.
Despite all this growth in cloud services Apple remains the cheapest stock among those profiled here, partly because many investors still don’t see it as a cloud company. That said, Apple is a major cloud player, and you should get in before the market realizes its potential.
Dana Blankenhorn is a financial journalist and futurist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he owned shares in AAPL and MSFT.
