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Equity Perspectives

Despite considerable economic headwinds, massive investments in "the cloud" are helping a number of companies reach new heights. And the trend remains strong.

 

In Brief:

  • The market for cloud services has mushroomed and redefined the IT industry.
  • Leading-edge tech companies born in the cloud have transformed their respective markets. Others are providing the platform for innovative start-ups to expand rapidly.
  • Among the many benefits are cost savings for both providers and customers, resource flexibility, and ease of use and speed of deployment. 
  • Even so, there is still a raging debate about the economic advantages of the public cloud versus the private cloud. 
  • For Lord Abbett equity portfolios, cloud exposure means companies across the capitalization spectrum. But throughout the range of market caps are companies that build on cloud, deliver their applications from the cloud (software as a service), and provide services to help customers transition to cloud.

 

Of all the technologies that have transformed small-, mid-, and large-cap companies, nothing quite compares to “the cloud”—a blanket term for the networks of data centers that have expanded the digital universe by delivering services over the Internet.

More than $1 trillion in information technology (IT) spending will be directly or indirectly affected by the shift to the cloud during the next five years, said Gartner, Inc., a technology research firm. This will make cloud computing one of the most disruptive forces of IT spending since the early days of the digital age.

"Cloud-first strategies are the foundation for staying relevant in a fast-paced world," said Ed Anderson, research vice president at Gartner. "The market for cloud services has grown to such an extent that it is now a notable percentage of total IT spending.” (See Table 1.)

Whether it’s software, hardware, networking, or services, cloud computing is redefining the entire IT industry, said Lord Abbett research analyst Rick Vallieres. In the process, cloud computing has also enabled strong growth in a number of sectors in a relatively slow economic environment.

“Today, we see leading-edge tech companies which were born in the cloud and have transformed their respective markets,” he added. “Others are providing the platform for innovative start-ups to expand at a rapid clip.”

As the CEO of one software service company born in the cloud put it, “Cloud computing is a better way to run your business.”

Among the many benefits are cost savings for both providers and customers; “pay as you go” pricing, resource flexibility, and ease of use and speed of deployment. 

For Lord Abbett equity portfolios, cloud exposure means inclusion of companies across the capitalization spectrum. “Large-cap names dominate the ‘infrastructure as a service’ market,” said Vallieres, “but throughout the market caps are companies that build on cloud, deliver their applications from the cloud [software as a service], and provide services to help customers transition to cloud.” 

 

Table 1. Cloud Shift Summary, by Market Segment

Source: Gartner, July 2016.
Note: BPaaS = business process as a service; IaaS = infrastructure as a service; PaaS = platform as a service; SaaS = software as a service.

 

The Expanding “Public” Cloud
While overall capital investment may be sluggish, recent research from International Data Corporation (IDC) shows worldwide revenues from public cloud services (e.g., social media, e-commerce services, digital content) alone reaching more than $195 billion in 2020. This would be more than double the $96.5 billion in revenues forecast for 2016, and represents a compound annual growth rate of 20.4% over the 2015–20 forecast period.

Cloud software—which comprises software applications as a service (SaaS), system infrastructure software (SIS) as a service, and platform as a service (PaaS)—was responsible for 83.7% of all public cloud revenue in 2015, with the remaining 16.3% belonging to infrastructure as a service (IaaS), IDC said. However, IaaS and PaaS revenues are forecast to grow at a faster rate than SaaS, expanding their share of overall revenues in the process.

"Cloud software will significantly outpace traditional software product delivery over the next five years, growing nearly three times faster than the software market as a whole, and becoming the significant growth driver to all functional software markets," said Benjamin McGrath, an IDC senior research analyst. "By 2020, about half of all new business software purchases will be of service-enabled software, and cloud software will constitute more than a quarter of all software sold."

Industries leading the way in public cloud-services spending are discrete manufacturing, banking, and professional services, which collectively represent nearly one-third of total worldwide revenues in 2016 (to date), IDC added.

The industries poised for the fastest revenue growth over the five-year forecast are media, telecommunications, and retail, IDC added. However, all 20 of the industries profiled in the IDC spending study are expected to see revenue growth of more than 100% over the forecast period.

"Cloud computing is breaking down traditional technology barriers, as line-of-business leaders and their IT organizations rely on the cloud to flexibly deliver IT resources at the lower cost and faster speed that they require,” said Eileen Smith, IDC program director, customer insights, and analysis. “Organizations across all industries are now free to adapt to market changes quicker and take more risks, as they are no longer bound by legacy IT constraints."    

Cloud Builders and Enablers
Cloud builders represent the most fundamental form of cloud computing. In assembling the building blocks of a highly adaptable warehouse-like infrastructure, these tech whizzes essentially reduce the cost of capital investment for established companies. They also make it easier for entrepreneurs to create new businesses by tapping into powerful computing resources at remote multi-tenant data centers using low-cost commodity hardware and virtualization.

“Infrastructure is the foundation that connects all the clouds—private [corporate applications and data], public, and home [devices like smart meters, wireless thermostats, Internet-enabled TVs],” said one provider of end-to-end provider solutions.2

Companies that specialize in cloud infrastructure have seen very strong growth. One of the biggest players in this space is the world’s dominant e-commerce retailer, which leveraged its domain expertise and started a web services division in 2006. By offering low-cost, expandable platforms and applications on demand to other companies, that rapidly growing division has become the outsourced cloud services company to beat.   

Among other secular growth stories in this space are a global purveyor of high-performance data centers and network services and a pioneering maker of storage memory platforms. Then there's a provider of virtualization software that vastly expands the capacity of Internet servers, supports the entire lifecycle of large-scale software development and storage on a single platform at potentially huge cost savings, and in turn allows a company to leverage its existing customer base.  

Now that all this laborious infrastructure is in place, platforms that allow people to interact, play, create, learn, or do business on multiple levels have morphed into global household names.

"Big Data" Moves to the Cloud Should Spur More Disruptive Innovation
No discussion of the cloud would be complete without mentioning "Big Data," a reference to companies powered by the latest open-ended software that makes machine-generated data accessible, usable, and valuable to everyone in a timely manner. There are many applications of such technology, but the most recognizable include transaction oversight for online businesses providing round-the-clock operations; tracking web activity and web asset-usage data to gain customer intelligence; and monitoring social media networks to identify trends and gauge sentiment.

When it comes to storage, discrete manufacturing, with its enormous demand for automation technology, has one of the largest appetites for data storage, followed by government, communications, and media. Laggards include the banking, healthcare, and the securities/investment sectors, where the need to protect incalculable amounts of critical information is further complicated by ever-changing regulatory requirements.  

Risks
For all the popularity of the rapidly expanding public cloud, some companies are adopting a hybrid approach of keeping some of their IT infrastructure in-house in a “private cloud,” given the enormous expense of transferring tremendous amounts of data to a new location, while developing newer, strategic applications on offsite servers.  

“In the financial services industry, for example, some companies prefer a private cloud over the public cloud, given regulatory impediments and a need for control of their data,” Vallieres explained. “Others are moving forward with public cloud for certain applications, while staying within regulatory allowances to prove their data is adequately protected.”

Whatever the industry, there is still a raging debate about the economic advantages of the public cloud versus the private cloud. One major player is trying to bridge both technologies, saying its approach is built for both closed source and open source operating systems and can make both of them harmonize with each other. And when it comes to putting applications in the public cloud, some companies are discovering that they can turn around and repackage and sell such apps to their own customers.

“Most companies have a pretty solid idea of what they’re going to do in the cloud, and they know the steps to get there,” said Vallieres. “It’s a time of enormous change in the industry, and the pressure on internal IT departments to deliver public cloud-style flexibility and economics is escalating.” 

 

1 "Worldwide Public Cloud Services Spending Forecast to Reach $195 Billion by 2020, According to IDC," BusinessWire, August 10, 2016. 
2 "Marvell’s All-Encompassing Cloud Services Solutions Power the Connected Lifestyle for Businesses and Consumers," PR Newswire, May 7, 2012.
3 Kash Rangan, Milesh Dhruv, and Jaimin Soni, "The Cloud Wars: From Disruptive to Pronounced to Tectonic," presentation, Bank of America Merrill Lynch Global Research, May 21, 2010.

 

The information provided here is for general informational purposes only. It doe s not constitute a recommendation nor investment advice , and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual re turns or results will not be materially different from those described here.

Investing involves risk, including possible loss of principal. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Small-cap company stocks tend to be more volatile and can be less liquid than large cap company stocks. Small and Mid-cap companies may be less able to weather economic shifts or other adverse developments than larger, more established companies and may have less experienced management and unproven track records. Small and Mid-cap companies may rely on limited product lines, may have more limited financial resources, and may be more susceptible to setbacks or economic downturns.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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