As the effects of last year’s “tech wreck” have receded, one point has become increasingly clear. Savvy investors now believe it’s wiser to rent the cloud than own it. This can be seen in the price action of the FAANG stocks over the last six months.
Four of these companies own their cloud infrastructure, only one does not. That one, Netflix, has seen a 7% gain in its share price during the period. The others are all down, and by more than the Nasdaq Composite average of 4.7%, even though with a total market cap of over $2.8 trillion they represent a substantial portion of that average.
Own or Rent?
Clouds are the most expensive form of basic infrastructure yet created. Facebook, which spends almost all its capital expenses on data centers, put $18 billion into capital expenditures last year. That’s fully one-third of its $55.8 billion in revenue. This is not news. Facebook was investing well ahead of its revenue early this decade.
Facebook took the risk and reaped the reward. But those rewards aren’t as rich as they were. The fashions have switched from owning the cloud to renting it.
This is true even though other costs keep the margins of the renters, most notably Netflix, well below those of the owners. Netflix brought just 7.5% of its revenue to the net income line last year, because it was putting its money to work producing movies and TV shows.
This has generated tremendous growth — Netflix 2018 revenues were 35% over those in 2017. But Facebook’s revenues were up 37%.
What’s the difference?
Cloud App Love
One difference is that no one is talking about breaking up Netflix, or any other cloud application company. There have been antitrust moves, or at least talk, about most of the biggest cloud owners lately, most notably Amazon, Google and Facebook.
The hottest group in private equity today are cloud-based enterprise applications. The recent purchase of Ultimate Software (NASDAQ:ULTI) by Hellman & Friedman, shows just how valuable they can be. Other examples are Workday (NASDAQ:WDAY), up 34.5% over the last six months and Salesforce.com (NASDAQ:CRM), up 10.5%.
Careful readers will notice there is one “cloud czar” missing from the list that started this article. That is Microsoft (NASDAQ:MSFT), whose shares are up 1.22% during this period.
The reason may be that Microsoft has done a great job both in selling its own enterprise applications on the Azure cloud and renting that capacity to other enterprise software companies, along with a platform that makes it very “sticky,” almost impossible to leave.
The Bottom Line
Companies in the cloud are currently being evaluated based on their power as software companies, including the cloud czars. The value of the infrastructure is being discounted, and its continuing independence from government control is being questioned.
But infrastructure is at the very bottom of the cloud stack. Before you can build a platform, or sell services in the cloud, you need to have a cloud. The Czars have the biggest clouds.
The history of technology shows that, over time, the bottom of the stack comes to control everything above it. That’s how Microsoft grew so powerful in the 1990s. You had to build on Windows to be a software player. Apple became powerful by controlling its software stack. Building cloud data centers in this decade is the final expression of that.
Fashions will change. At some point, investors will realize that it’s better to be the King than depend on one.
Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at [email protected] or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in AAPL, AMZN and MSFT.