When Amazon released the first earnings numbers for its cloud business earlier this year, it was like lightning striking the global tech sector, says Richard Saldanha

Key points

  • The potential inherent in their cloud businesses has electrified the valuations of Amazon, Microsoft and Google this year
  • Listed companies are quickly recognising the benefits of ‘renting’ rather than ‘buying’ their IT in a global market estimated to be worth over US$1 trillion a year
  • The accelerating migration to the cloud has been a key factor in numerous tech deals and will continue to shape the global tech market for many years to come
  • Even securing a small percentage of the potential cloud market stands to be incredibly lucrative for those companies with the will to invest in the sector

Thanks to the success of their cloud offerings, Amazon, Microsoft and Alphabet (Google) have seen their market caps gain in the region of US$350 billion since the start of the year, signalling the dawn of a new era for the technology sector.

Back in 1997, just after his return to Apple, the redoubtable Steve Jobs began telling audiences about the potential of cloud computing. It took another 15 years for the arrival of iCloud but, as with most things, Mr Jobs’ vision was frighteningly prescient. Today there are estimated to be around 500 million iCloud users alone while other consumer-based offerings such as Dropbox, Spotify and Gmail are already engrained in everyday life and the demand for data storage, due to the growth in internet traffic, video, social media and gaming, continues to surge.

However, the cloud’s greatest potential lies in the business sector, where it’s responsible for a paradigm shift from ‘old tech’ to ‘new tech’. This, in turn, is creating a new generation of champions in the global tech sector as businesses of all sizes migrate to a new model of ‘renting’ their technology rather than buying it. The opportunity for ‘enterprise’ businesses – namely those companies that can offer outsourced services to large corporations covering everything from servers and storage to infrastructure, data management and application software – is vast, with a total annual market estimated to be worth well over a trillion dollars a year.

A towering presence

So far, it’s been Amazon that has blazed a trail in this sector. It launched Amazon Web Services (AWS) back in 2006 and was followed a year or two later by Microsoft Azure, Google’s Cloud Platform and a flotilla of smaller specialist operators. Until earlier this year, although the cloud’s potential was well recognised, because the key players had not yet published earnings figures for their cloud start-ups, little was actually known about the profitability of such ventures.

With Amazon leading the field, the prevailing view among most analysts was that, true to form, Amazon’s business model of cost-cutting and wafer thin margins would lead to a ‘race to the bottom’ in the sector. However, such thinking was turned on its head in the first quarter of this year when Amazon revealed that operating margins for its AWS business were a prodigious 17 per cent. By the third quarter, AWS had posted revenues of US$2.1 billion, a second consecutive quarter of circa 80 per cent annual growth. This puts annualised revenue at US$8.3 billion – already eight per cent of total Amazon revenues – and has analysts in the sector describing AWS as the “fastest growing enterprise technology company in history”.

Amazon’s disclosure lit the touch paper under its share price, which has more than doubled this year. The valuations of its nearest rivals Microsoft, which has reported annualised Azure revenues of US$1.4 billion that are growing at a clip of 135 per cent, and Alphabet’s Google have also benefitted with total market cap gains for these three currently close to US$350 billion this year. Much of this has already come at the expense of the existing enterprise giants like Oracle, IBM, Hewlett Packard or VMware.

A high-pressure front

The accelerating adoption of the public cloud is exerting immense pressure on the ‘legacy’ providers of the enterprise IT world and has been a key factor in numerous deals within the sector such as the recent EMC-Dell merger, the break-up of HP or VMware’s plans to absorb EMC’s cloud infrastructure business. It has prompted a number of smaller players to turn back into private companies and is driving the new ‘cloud-first’ rhetoric that is now coming from the likes of IBM, Oracle and SAP.

While all this is underway in the software industry, the growing maturity of the PC and disk storage markets has already sparked a flurry of M&A activity in the semiconductor market such as the recent Intel/Altera and Avago/Broadcom deals. With consolidation already underway in the sector, we also expect to see more instances of players like Intel ‘jumping the fence’ and targeting the data centre market due to the spoils that are still on offer.

However, the sector presents a number of barriers to entry, most notably the cost of building major data storage centres. A construction boom is already underway here led by AWS and Azure with Google bringing up the rear. Soon AWS will have 84 data centres worldwide and an estimated five million servers.

Meanwhile, Microsoft’s cloud is already available in more than 20 regions while the company is suggesting it has the capacity to bring more than 11 million servers online when it’s done.

The mind-boggling capacity this is creating has reduced the cost of launching internet businesses by so much that it can only accelerate the flow of new ‘born on the cloud’ companies such as Netflix or WhatsApp.

At the same time, it’s putting tremendous pressure on established businesses to embrace the cloud and the cost savings it engenders. Leading analysts now expect cloud adoption to hit 50 per cent in the next three to four years with industry goliaths such as GE, News Corp, Coca-Cola and Yamaha already among those that have announced major migrations to the cloud. Even the CIA, with the help of AWS, is building its own cloud.

Although few new arrivals can hope to overhaul the sector’s leading names, the cloud business is so great that even securing a small percentage of the total market stands to be incredibly lucrative for those businesses agile enough to embrace what’s likely to be the greatest growth story of the decade. This is a theme that will reshape the global tech market creating a new breed of winners and losers as it goes

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