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Tech Stocks

The Quiet Partner to Public Cloud Companies

By Jason R. Koepke, on Jan. 9, 2017

Cloud technology has become a catch-all answer to almost any software or business challenge, to the point of being cliché. That’s nice if you’re creating a pitch deck, but if you’re investing your money, you need to crack open that cliché and understand what’s happening.

Most of the time we hear about the cloud, it’s treated as being monolithic—a way for all the online services to work. It covers a dizzying array of products and services: how we write and share documents (Office 365), share photos and see what others are doing (Instagram), send messages (Slack), email friends (Gmail) or watch movies (Netflix).

The first wave of cloud providers focused on providing the “bare metal” that companies used to quickly establish a data center. Providing that infrastructure eliminated the mighty start-up costs associated with buying servers and hiring people to set up the racks, monitor the health of the servers, and maintain them.

But running large data centers filled with commodity hardware and the most basic of services also means low margins. Amazon.com (NSDQ: AMZN) got into the business, because it already had these data centers for its online retail operations and thought it could monetize the unused cycles of its servers by renting them to others. It worked.

Tech giants with their own unused servers sitting in various data centers realized the revenue possibilities and dove in. Given Amazon.com’s cutthroat pricing and the inherently low margins of renting out just the hardware and data center space, cloud providers wanted to move up the value chain (or up the stack, in industry parlance). It’s one thing to rent out servers with only the basics and quite another to make available the various operating systems, databases and platforms developers use in everything they build.

In doing so, cloud providers sought to differentiate themselves. Amazon AWS (the company’s cloud services unit) focused on low costs and constant new offerings. Microsoft Corp’s (NSDQ: MSFT) Azure established itself by making it easy for quickly transfer applications written for Windows to a cloud architecture and then built out the basic bare-metal offerings. And Alphabet’s (NSDQ: GOOG) Google Cloud used Google’s experience at running huge networks and products to make it easy for other companies to build their own complicated cloud systems.

Other companies are in the mix, but none rival these three.

Rackspace Hosting serves as a good example of how companies evolved and sought to establish their own market position. The company started as a basic webhost, before quickly transitioning to an infrastructure-as-a-service provider. Unable to compete against AWS pricing, Rackspace Hosting began offering hands-on support, giving companies the infrastructure and platforms they needed as well as ready-to-consult IT team.

Eight years after going public, it was taken out by a private-equity company and focused on being a managed cloud provider­­–an IT services company that supports other companies’ use of AWS, Azure, Compute and/or other options.

So far we’ve only looked at the public cloud–data centers built and managed by a third party. But there’s another world, and another differentiator.

A Cloudy Mix

On the one hand, there’s the public cloud, where a company’s data is stored and computing run by a third-party company at another site. On the other hand, there’s the private cloud, which is the new name for a company buying, running, and using its own data centers with its own staff.

And investors shouldn’t overlook the excluded middle. Put most simply, companies can put some of their processing and storage needs in the cloud and keep some in their own data centers.

Most companies have pursued this hybrid approach. But many tech companies didn’t focus on this opportunity set because the growth opportunities—in sales, in new technologies, in new capabilities, and in share prices—focused on the public cloud.

In late 2013 and early 2014, industry insiders began to realize how well the two approaches could work and the benefits of each leveraged. Let the new hype cycle begin.

Fast-forward to 2016 and companies, even cutting edge Silicon Valley types, have realized that the hybrid cloud may be the smartest forward.

This shift is reflects cloud computing’s cost advantage over other solutions.

Early on, the idea quickly caught hold that public cloud would be cheaper than a private data center. After all, companies that specialize in doing one thing well can often do it better, quicker, and less expensively than a company that also has to focus on selling widgets.

That may have been the case initially, when services were relatively simple and providers kept prices low to establish market share. But now that online systems have grown more complex, the costs add up.

The value gain of going cloud still exists for small or midsize companies. At a certain size, though, the scale that lets cloud providers profit from reasonable margins also enables big companies save money.

Cost also is directly related to a technical challenge. Given that public-cloud setups mean that multiple companies’ rented systems share space in the same data center, their evolving needs may butt up against one another. Low-stress workloads may not feel any pain, but if a company needs to run a data analytics jobs or move enormous amounts of data around to serve customers with files, the resulting competition for resources can lead to bottlenecks.

Companies who suffer from these bottlenecks can either pay even more for more reliable service or break out of cloud jail and take some of its data home to a private cloud.

As a result, very large companies and very data-intensive companies find public cloud options viable for some, but not all, applications. The trick is identifying that “some” and ensuring the systems that link the public work and private work function seamlessly.

There are companies that continue to strive in the private cloud world and have established growth paths for hybrid and public cloud models. With proven track records and momentum behind hybrid models, these companies’s stocks are worth watching.

In fact, our favorite company of the bunch recently saw its stock pullback due to a knee-jerk reaction on some bad news. And in the most recent issue of Capitalist Times Premium, we covered the company and the opportunity, which still has plenty of recovery room left, even now.

If you’re not a subscriber, do so today. You’ll not only learn about this opportunity, but you’ll also receive new investment advice and portfolio alerts from Elliott Gue and Roger Conrad.

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