From East Los Capital blog: https://eastloscap.com/2020/02/10/quarterly-results-from-the-mega-cloud-providers-not-as-cloudy-as-thought/
Over the past several quarters, Wall Street has been laser focused on signs of slowing growth amongst the hyperscale cloud providers. In recent quarters, these tech giants represented by Amazon, Microsoft, and Google have provided just enough uncertainty in their results to rattle investors concerned about slowing growth rates. In Q3 of 2019, Amazon stock was punished by investors after it reported AWS results that were slightly below analyst estimates and pointed to a potential slowdown in infrastructure. These companies have been growing at truly impressive rates for years (AWS launched as a commercial service in 2006). Despite the tremendous opportunity that is still ahead of them, it would not be unexpected to see some slowing in growth rates as the law of large numbers begins to take hold.
Intel surprises and scares
In the most recent earnings season where companies reported results for the quarter ending December, 2019, Intel once again gave investors reason to be nervous as they reported strong results with what many perceived as conflicting commentary and guidance. Intel management reported results that beat quarterly expectations driven by strong demand in their cloud business (data centers) and remarked that there is an insatiable appetite for data driving the cloud – “they need more compute, more storage, and need to move data faster which places demand on the cloud players.” But then management threw investors a curve ball with their CFO stating that after the first quarter the company expects “more modest capacity expansion for the remainder of the year” as cloud clients “move to a digestion phase.” Management alluded to short term distortions in demand signals for their reluctance to be more aggressive in second half forecasts. “The cloud providers come in big spurts, they buy a lot, they ingest it, they consume it, they suspend their buying and then they come back in big waves.” Investors looked forward to commentary from the Big 3 cloud providers to see just how big, or small, these waves might be.
AWS rights the ship
Amazon regained investor support on the back of strong results at AWS which exceeded expectations. Revenues of $9.9 billion during the quarter reflected 34% year over year growth, which, although a very slight deceleration from the prior quarter, was enough to satisfy skeptical investors who had begun to question the sustainability of these types of growth rates from a company that now boasts a trillion dollar market cap. Operating margins expanded, so any argument that growth was being achieved at the expense of profitability was mollified. Importantly, AWS long term commitments of $30.0 billion maintained over 50% growth. AWS continues to grow revenue as a result of the company’s push into large scale enterprise customers and strong adoption of new AWS products and features. Amazon also announced that it is extending the useful life of its servers from 3 years to 4 years which is consistent with the data center efficiency investments Amazon has discussed over the last couple of years. While this may not be good news for the hardware players (and might explain some of the comments by Intel) we view increased efficiency at AWS as good for the overall health of the cloud space. Efficiency drives pricing which drives adoption.
Azure continues its sizzling growth
Microsoft does not disclose actual revenue numbers for Azure but they do disclose growth rates and a reacceleration to 64% year on year growth was enough to cheer investors and put to rest any near term concerns about slowing growth. Management boasted about “very good and healthy broad base consumption growth, especially in IaaS and PaaS.” They specifically called out that it not only had good workload migration work and strong growth in the optimization of the workloads already running, but the fact that some of these new PaaS workloads, like Synapse and Cosmo DB, and Arc are starting to add some momentum in that part of the stack. This bodes well for continued growth. In Azure, revenue growth will continue to reflect a balance of strong growth from consumption based business and moderating growth in per-user businesses, given the size of the installed base. While gross margins are expected to continue to improve, the rate of improvement will decline due to this mix shift. Management touted new products and features across analytics, AI, the edge, hybrid computing, quantum, and their exclusive relationship with SAP. All in all, an impressive quarter for the company. A CNBC talking head was recently heard postulating that if the company were to change its name to Azure it would see an instant bump in valuation as images of Windows and desktops were replaced with cutting edge cloud technologies. Management might want to take that under advisement.
Alphabet surprises with good results and increased disclosure
Google rounded out the reporting results of the cloud providers with perhaps the most interesting development in that management decided to break out cloud results separately. There is no greater joy for analysts than to see the actual numbers that they have been
guessing at forecasting for years.
Revenues from Google’s Cloud business accelerated to 53% Y/Y growth in FY19 (vs. 44% in FY18) with the business on a $10 billion run rate as of Q4’19. Google Cloud Platform (GCP) is growing “materially higher” than overall Cloud with management noting particular strength in their Data Analytics products.
Year on year, the number of deals over $50 million more than doubled with investments in Cloud’s go-to-market expansion resulting in customer momentum. Large customers who are making multi-year commitments resulted in a backlog which ended the year at $11.4 billion. As evidence of the company’s commitment to being the #2 player in cloud by 2023, the majority of new hires were engineers and product managers with the most sizable headcount increases being within Google Cloud.
Google is embracing its position of “challenger” by investing aggressively with a focus on building out go-to-market capabilities and executing against a product roadmap that extends the global footprint of their infrastructure to focus on 21 markets and 6 industries. The cloud team is on track to triple the sales force in three years, which includes bringing in a number of senior strategic hires and supplementing them with the channel partnership program.
Take Aways for investment in IT Service/MSPs/cloud integrators
The cloud is strong, healthy, and increasingly larger. Even with growth rates that are naturally declining, the absolute dollars spent on the cloud is increasing. Total IaaS/PaaS revenue from the Big 3 cloud providers grew from $6.9 billion in Q4’17 to approximately $16.0 billion in the quarter which just ended. At East Los Capital, we regularly speak with cloud executives in order to have a pulse on the industry. Most cloud executives state that the largest bottleneck to growth is partners which can assist customers in the integration of their increasingly broad and complex product offerings. This is fertile ground and a gigantic opportunity for partners which have or can obtain the necessary engineering talent, certifications, and scale to assist businesses and the cloud providers in what will be an ongoing and lengthy transition to the cloud. Along with the transition comes an increasing need for managed services and customized application development. The best positioned cloud services partners will reap the rewards.