The Rising Influence of Rising Affluence

[DewDiligence]

As Big Enterprises Move to The Cloud, ‘Big Tech’ Worries

[Why are there so few posts on this board about such Big Tech companies as CSCO, ORCL, HPQ, INTC, and IBM? Surely, as The Global Demographic Tailwind drives consumers in emerging markets into the middle class and grows enterprises who serve their newfound wants, these enterprises will need more computer hardware and software. Thus, one would think Big Tech would be a clear beneficiary of TGDT. There’s one little problem, however: The Cloud. Thanks to The Cloud, it may be a stretch to think that the traditional tech giants are going to have a nice run in the next 5-10 years. I don’t own any of them; if I’m missing something, please let me know!]

http://online.barrons.com/article/SB50001424053111904502004575562243330821352.html

›OCTOBER 23, 2010
By MARK VEVERKA

It turns out this cloud has a dark side for technology vendors—and their shareholders.

Corporate adoption of efficiency-enhancing virtualized computer networks, known as "private" clouds, is going so well that big companies may be ready for the next phase of cloud computing years sooner than either Wall Street or Silicon Valley expected. That's not a welcome development for the technology suppliers that sell Corporate America hardware and software because the next step is the outsourcing of many data-processing services. In other words, corporate customers gradually will be cutting back on big-ticket items and redirecting smaller amounts of money to computer-services providers.

"It's possible that we could see another nuclear winter in tech spending," says Walter Price Jr., who has been managing technology funds for more than 25 years.

The consensus has been that big, global companies, already sitting on record mounds of cash and reporting improved revenues and profits, would steadily increase their spending over the next few years as the recovery gradually gained steam. Information-technology stocks would enjoy the ride.

But that's not really happening. Even without the effects of cloud computing, Goldman Sachs now sees 2009's declining global information-technology sales followed by about 5% growth this year and 3% in 2011 as a subpar recovery takes hold (see chart nearby). Price contends that it could get worse than that. "What's coming is a secular decline in tech spending," he says. "We are headed to an environment where it will be difficult for [tech vendors] to keep revenues growing."

Price expects the technology portion of capital-spending budgets to fall as corporate networks head into this new stage–known as "public" cloud computing—in which more tasks are handled, possibly by a new group of technology outfits, for a fee.

To date, Amazon.com (ticker: AMZN) is the leading computer-service provider followed by Google (GOOG) and Microsoft (MSFT). There are numerous companies that provide software-as-a-service from the cloud such as Intuit (INTU). Those with the most to lose in the coming transition are Hewlett-Packard (HPQ), Dell (DELL), Oracle (ORCL), Cisco Systems (CSCO) and IBM (IBM).

The notion of cloud computing comes from the interconnection of computer-data centers via a network connected to the Internet. New virtualization technology is pushing this trend. Server-virtualization software, especially that sold by market-leader VMWare (VMW), allows one computer to take the place of several machines by running more than one operating system and then allocating resources where they're needed to increase efficiency. In short, it takes fewer machines, fewer employees, less electricity and less software to do the same job. The rapid growth of VMWare and its cloud-enabling technology is another sign of companies' speedy adoption of the concept.

A private cloud generally is owned and operated by the company that deploys it. The ultimate transition to a public cloud means that almost all its information-technology operations could be managed by a third party that owns clusters of hugely powerful data centers. That is where Amazon and Google come in. In its simplest form, a company would access its data when it wanted through the Internet, the same way a consumer can now access Turbo Tax software without having to store all the information on his own computer.

The process is well under way. According to a 2009 survey of technology vendors by independent research boutique Primary Global Research, at least 10% of those polled said the cloud would be part of their strategy by 2011. Yet the firm now estimates that 80% of its survey group already are working on an implementation plan that includes cloud computing. Among the early adopters of private cloud technologies have been Revlon (REV) and Charles Schwab (SCHW). In Europe, the pace is even quicker. Royal Dutch Shell (RDS) has signed a five-year contract to shift its data centers in the U.S., Netherlands and Malaysia to a public cloud run by a Deutsche Telekom unit.

Primary Global, says Chief Executive Unni Narayanan, was sufficiently impressed with the possibilities that it shifted its own human-resources function to a privately held cloud company called HireDesk. Primary Global had paid about $100,000 to install its existing HR software and then roughly $15,000 in annual maintenance. It now pays about $6,000 a year to access this information via HireDesk's cloud-computing operation.

Such economics, says Price, could mean the most dramatic transformation of enterprise technology in 20 years arrives ahead of schedule. It would be comparable to the disruption caused when client-server personal-computer systems surpassed mini-computers and big-iron mainframes. Think Wang, Digital Equipment Corp., Sperry and Burroughs [and Prime Computer, Data General, and several other companies from the minicomputer heyday].

In the very near term, companies will continue to invest in their own private cloud-computer systems. That will benefit the traditional tech behemoths that sell servers, storage, personal computers and business software, such as IBM (IBM); HP; Dell; Oracle and Cisco. But the markets already are starting to make longer term distinctions. With the exception of IBM, these stocks have been trading at depressed valuations because they are mature companies, says Paul Wick, technology-portfolio manager at Seligman Investments.

And the clock is ticking for the current giants. The ultimate "public-cloud" model is analogous to power utilities, where computing power would be sold based on usage and need.

Primary Global's Narayanan agrees that today's enterprise-technology vendors are at risk of becoming obsolete. "There is a constant tension between addressing short-term immediate problems versus directing resources to potentially huge untapped markets," he says. "And so, technologists vacillate between tactical thinking for today and strategic planning for tomorrow."

Portfolio manager Price is betting that the global scale of Amazon and Google gives them an advantage; their data-center facilities already dot the world, offering the potential for high-quality services, analytics and applications at lower costs. Their shares are pricey, thanks to their core e-commerce and advertising businesses, trading at forward price/earnings ratios of 46 and 18, respectively. But Price argues that investors have to pay up for growth to own the industry leaders. Amazon and Google shares were trading last week around 169.13 and 612.53, respectively.

A new generation of Silicon Valley start ups, such as social-networking and mobile-services companies, have integrated Amazon and Google cloud services into their offerings. As they grow, Amazon and Google will grow, too. Price thinks Amazon's market-cap of $69 billion could grow as much as 45% to $100 billion in just two to three years.

Microsoft has the heft, engineering prowess and potential scale to compete, but it started after Amazon and Google and faces headwinds in its other businesses. Microsoft's Azure unit isn't aimed at offering infrastructure to users the way Amazon and Google do, but is offering a platform as a service where customers can host myriad Web-based software applications. IBM is another possible contender, though to date it's focused on Web services that can facilitate the building of private-cloud networks, Narayanan says.

For client-server era giants like Cisco, Oracle and HP to get in the game, it will probably require some key acquisitions, Price thinks. As their customers turn to the cloud, these fierce competitors will be fighting over a shrinking enterprise pie, increasingly selling their servers, storage and networking gear to what's expected to be just a handful of major cloud-service providers.

Potential targets could include publicly held cloud computing pure-plays, such Rackspace Hosting (RAX), Terremark Worldwide (TMRK), and Savvis (SVVS), says Global's Narayanan. These companies started largely as places where customers could locate their data centers cheaply without having to own the space. They are now tackling the tougher task of evolving beyond this commodity-type business to become value-added cloud-services operations.

But there are a bevy of privately held and well-funded cloud-services outfits that might make for attractive takeover targets, including Joyent and Go Grid. Joyent is a six-year old San Francisco company that provides cloud services to thousands of customers, including professional networking-service Linked In. Intel (INTC) and Peter Thiel, a backer of Facebook, provided venture backing. Go Grid is a smaller private company.

Price's favorite picks to become big winners in the cloud era are software-as-a-service outfits companies that host business software applications and provide them as a subscription service via the Internet.

The poster child is Salesforce.com (CRM), which Price thinks can more than double its $14 billion market valuation to $30 billion in three years. He also predicts that trailing annual revenues of about $1.46 billion can grow 30% a year. Salesforce provides on-demand customer-relations management software applications. Salesforce shares, which trade about 69 times forward-earnings, changed hands at 105 last week.

Price is also high on the growth prospects of Intuit, the creator of Quicken personal-finance software; is poised to become the cloud-based provider of accounting and other financial software to small businesses. He thinks Intuit's market cap of $14 billion can increase 30% over the next two-three years. Shares were trading about 17 times forward earnings last week, closing Friday at 47.21.

Two other software-as-a-service companies to watch are SuccessFactors (SFSF) and Concur Technologies (CNQR). Price views them as niche players in enterprise applications that could do well in their relatively narrow categories. SuccessFactors, which provides business execution applications such as those used for employee performance, is also pricey with a P/E ratio of 219. Shares closed Friday at 25.87. In a recent story, Barron's found the pricing too rich. Concur provides expense-reporting applications on demand, eliminating the need for paper and pencil reports. The stock was changing hands at 49.14 at Friday's close, or about 51 times forward-looking earnings.

With the exception of Microsoft, Intuit and Google, these are all pricey stocks. Investors may have to pay up if they want to benefit from companies' zeal to cut their information-technology costs. Remember, this decade's tech star could emerge from this group.‹