Global tech: gaining from the growing dominance of cloud infrastructure

27/07/2016

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​Alison Porter, portfolio manager in Henderson’s Global Technology Team, discusses the disruptive trend of cloud infrastructure, and explains why it is a long-term growth trend worth banking on.

A disruptive technology displaces an established technology, shakes up an industry or is a ground-breaking product that can create a whole new industry. The move to cloud infrastructure has the potential to be one of the most disruptive trends in technology over the next 20 years and is among the current investment themes in the Henderson Global Technology Strategy.
 
What is cloud infrastructure?
 
Historically most companies managed their IT resources (servers, storage, devices and networking equipment) as well as the software (infrastructure and applications) on their own premises. Public cloud refers to datacentres that are operated by third parties and located away from the company’s own premises. These large data centres typically run on shared or standardised technology equipment (storage, networking, servers, and databases) optimised for maximum usage and have more than one customer/tenant sharing the infrastructure.  We continue to see other cloud infrastructure models emerging including private cloud ( shared resources and only one tenant) and hybrid cloud (a mix of cloud and traditional owned on site  IT). 
 
Why move to the cloud?
 
The concept of public cloud was introduced by Amazon via Amazon Web Services (AWS). The idea of shared online IT resources began initially as a cost saving tool with a per minute billing structure for compute and storage capacity.  This ‘rent rather than buy’ structure shifts IT spending from capital budgets to operating expenditure and has been very popular with start-up internet companies. Public cloud provides upfront cost savings and enables rapid growth as clients have the flexibility of provisioning IT capacity on demand.
 
Cloud infrastructure has helped to lower IT infrastructure costs for new companies. Many internet start-ups (eg. Uber, Spotify, and Airbnb) have grown rapidly and the cloud model is now increasingly being adopted by large corporates looking to reduce costs and increase flexibility particularly in the testing and development phase of new products.   In 2014, The US Central Intelligence Agency (CIA) announced that they would move their data to a cloud infrastructure.  A move viewed as an endorsement of the security features of the cloud. General Electric and Newscorp are among other large companies that have announced they will be moving the majority of their IT workloads to a public cloud structure over the next three to five years.
 
A sizeable and rapidly growing market
 
Estimates of the size of the cloud infrastructure market appear conservative to us as these numbers represent only a small proportion of overall enterprise IT spending. The model’s features and functionality available in cloud infrastructure are expanding rapidly, growing the addressable market for cloud infrastructure. This is having an increasing impact on legacy technology companies, most notably on the sale of legacy hardware, where incumbents are reorganising themselves to compete better (eg. the acquisition of EMC by Dell and the break up of Hewlett Packard).  It is important to note that while we are optimistic on the growth of cloud infrastructure we do not believe that 100% of IT workloads will be moved on to a cloud infrastructure.  There are many companies that will want to maintain part or all of their IT on their own premises for scale and control reasons hence the popularity of other cloud models such as hybrid cloud.
 
Size of public cloud market
 


 
Source: Goldman Sachs, data as at January 2015.
 
  
Scale driving profitability for Amazon Web Services
 


Source: Stifel, company reports, data as at 30 September 2015. Past performance is not an indicator of future performance.

 

Stock implications 

The cloud infrastructure market remains in its early stages. Amazon invested early and heavily, and in 2015 AWS’s cloud business was more than four times the size of the second largest player - Microsoft’s (Azure). Both Microsoft and Alphabet (formerly Google) are now investing heavily to play catch up. Notably, while cloud infrastructure is an important driver of Amazon’s profitability, it remains a very small part of Microsoft and Alphabet’s business. The amount of capital required to operate and scale a cloud business creates significant barriers to entry for other smaller players. We believe that after initially competing on price for compute and storage services, competition is now evolving to the creation of new products and functionality; with Alphabet, Microsoft and Amazon the winners in their own niches. These three stocks feature in our strategy’s cloud infrastructure theme as we expect these companies to dominate the growth of cloud infrastructure over the next five years. The IT needs of these three companies with ‘hyperscale‘ data centre environments are different from traditional enterprise buyers as they are technically more self-sufficient and require less sales and services support than traditional IT buyers. Companies like Arista Networks and Broadcom (both also held in our portfolios) design products specifically for these ‘hyperscalers’ and so also benefit from growth in cloud infrastructure.


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