Drawing Capital Newsletter
August 28, 2020
This week, we explore the technology landscape, the current state of cloud computing, and a range of insights and trends related to the cloud computing space.
Three Technology Waves
Over the past 40 years, there have been 3 overarching waves of technology:
The third wave is multifaceted with Cloud being one technology among many.
What is Cloud Computing?
Cloud computing is defined as the on-demand availability of computing resources, data storage, and analytics allowing for shared resources and economies of scale.
Cloud computing lives on three major service stack layers:
Why Cloud Computing Matters
Cloud computing solves large enterprise and consumer problems and abstracts away a lot of complexity in infrastructure and scaling. 20 years ago, many engineers were still racking servers and randomly hiring infrastructure engineers to accommodate future growth. Today, AWS and other tech tools reduce the cost of entrepreneurship in getting started and allow thousands of companies to enjoy the benefits of cloud adoption in their digital transformation journey.
Overall, the growth of cloud computing has exponentially increased. When we are talking in billions, of course, it is important. When there are a trillion dollars at stake, there is a generational impact (1):
In 2000, there was no solely independent public cloud company.
In 2008, the top 5 public cloud companies had an estimated market cap of $14B, led by Salesforce, NetSuite, and Concur.
In February 2020, the total market cap of publicly traded cloud computing companies exceeded $1 trillion.
Major Uses of Cloud
The initial creation of cloud software services was based on a growing need inside Amazon and other large tech companies to manage and optimize their data infrastructure. Here are some examples.
As more data is collected during the shift to digital, companies need more storage. Buying and connecting hundreds to thousands of hard drives is no longer practical nor cost-effective. Cloud has provided a solution for anyone to store virtually any amount of data with little overhead.
Traditionally, scaling software to support more users required purchasing more hardware and paying more engineers to install it which costs time and money. The Cloud lets you request more resources with the click of a button while saving money when your computing needs are low.
Machine Learning (ML)
Some ML models require lots of data to train on which may require massive amounts of memory and compute power. One big issue with training models is ensuring there are enough resources while the model is training otherwise all progress will be lost. It is much safer to train on the Cloud where hardware is extremely reliable and you only pay for the time used.
Here are some other reasons why Cloud Computing has grown rapidly.
Stable compute resources with high availability and reliability
Ubiquitous access to computing resources across a range of platforms
Substantial innovation in infrastructure, hardware computing resources, GPUs, TPUs, and AI chips
Proliferation of machine intelligent techniques to solve increasingly complex problems and increase efficiencies, such as artificial intelligence, machine learning, neural networks, and deep learning
High demand for real-time analytics
Rise in automation at scale
Major Cloud Computing Platforms
Below is a revenue comparison of the major players.
The benefits of scale for major cloud service providers include:
greater reliability of service to customers
more features at competitive prices
the ability to hire and retain talent
the utilization of network effects to drive enhancements for multiple customers at once
Beyond these three mega cloud service providers, there is an entire ecosystem worth over a $1 trillion in market cap of large public companies, private unicorns, and startups that are innovating in the cloud.
Insights & Related Trends
There is a difference between edge computing, cloud computing, cloud service providers, cloud-enabled companies, and SaaS. Many cloud-enabled companies often deliver a product or service to the end enterprise customer or consumer via a SaaS business model.
A “tech tax” exists for thousands of companies. Startups spend almost 40 cents of every dollar fundraised from venture capitalists on advertising, cloud computing, and other services from Google, Facebook, and Amazon (5).
An asset’s value is the present value of its discounted future cash flows. Although price multiples provide an incomplete picture of a company’s valuation, they can be helpful in understanding investor appetite, level of confidence, and risk tolerance. When markets price a low P/E multiple, markets are either providing an undervalued investment opportunity to investors or questioning the future durability or growth of the company’s earnings. When markets price a high P/E multiple, there are high expectations for future financial growth.
Investor mindset and valuation frameworks are evolving, particularly for technology, SaaS, and cloud computing companies. Simply stated, having a “long the disruptors and short the disrupted” investing approach worked well over the past decade. Some traditional valuation metrics, such as P/E ratios, can work well for stable, value-oriented businesses that exhibit repeatable earnings with stable or linear growth; however, we need a different set of financial metrics for valuing exponentially growing cloud and SaaS businesses. Examples include revenue growth rate, gross margin, contribution margin, net dollar retention, variable costs, customer acquisition costs, lifetime value, quality of the annual recurring revenue, customer churn, cash conversion score, return on invested capital, the Rule of 40, various price multiples, and more.
The rise in automation at scale is transforming businesses worldwide, and cloud computing and big data processing will continue to provide the tools to empower this digital transformation.
Video conferencing, virtual applications, productivity tools, and the creation of the deskless workspace in the cloud will all enhance employee efficiency and corporate productivity. While the paradigm shift unfortunately was triggered by the COVID-19 crisis, many work-from-home tools are here to stay. As the future of work changes to a more remote-friendly work environment, there will be an automatically increased demand in cloud computing usage.
Many Fortune 1000 companies are still in their early stages in adopting the cloud, and hence why the potential future opportunity is immense. According to McKinsey’s rough estimate last year, only about 20% of enterprise data is in the process of migration to the cloud, representing a large future growth opportunity (6). For companies to fully enjoy many digital transformation efforts, the majority of workloads need to move into the cloud with modernized UI-friendly applications. As a result, we believe cloud adoption is an unstoppable trend in the near term.
As measured by the BVP NASDAQ Cloud Index, a cohort of cloud companies have rapidly growing stock prices and revenue growth rates. Created in August 2013 in partnership with Bessemer Venture Partners and NASDAQ, the BVP NASDAQ Cloud Index has delivered substantial performance alpha compared to major US equity market indices. Since its inception in August 2013 to August 26, 2020, the BVP NASDAQ Cloud Index is up about 848%. For comparison purposes, the NASDAQ is up about 222%, the S&P 500 Index is up about 110%, and the Dow Jones Industrial Average is up about 88% in the same time frame (7).
We believe the Cloud is incredibly under-invested and is experiencing a hyper-growth phase. Viewing the data, the WisdomTree Cloud Computing ETF (ticker: WCLD) has about $667M in assets under management as of August 26, 2020, and tracks the BVP NASDAQ Cloud Index (8). The SPDR Dow Jones Industrial Average ETF (ticker: DIA) has about $23B in assets under management as of August 26, 2020 (9). This data implies that the DIA ETF manages about 35 times the amount of assets compared to the WCLD ETF, yet the Dow Jones Industrial Average Index has cumulatively lagged the BVP NASDAQ Cloud Index by about 760% since August 2013.
In summary, we have discussed the three overarching technological waves, provided a summary of the current state of the cloud computing industry, displayed historical growth rates in cloud companies, and shared insights and related trends. We believe the cloud computing industry remains a disruptive innovation engine with an incredibly compelling and rich opportunity set in the coming decade ahead.
(1) "State of the Cloud 2020 · Bessemer Venture Partners." 22 Apr. 2020, https://www.bvp.com/atlas/state-of-the-cloud-2020/. Accessed 26 Aug. 2020.
(2) "Amazon.com Announces Fourth Quarter Sales up 21% to ...." 30 Jan. 2020, https://press.aboutamazon.com/news-releases/news-release-details/amazoncom-announces-fourth-quarter-sales-21-874-billion/. Accessed 26 Aug. 2020.
(3) "GOOG Exhibit 99.1 Q4 2019 - Alphabet." 3 Feb. 2020, https://abc.xyz/investor/static/pdf/2019Q4_alphabet_earnings_release.pdf. Accessed 26 Aug. 2020.
(4) "FY20 Q2 - Press Releases - Investor Relations - Microsoft." 29 Jan. 2020, https://www.microsoft.com/en-us/Investor/earnings/FY-2020-Q2/press-release-webcast. Accessed 26 Aug. 2020.
(5) "Annual Letter - Social Capital." 31 Oct. 2018, https://www.socialcapital.com/annual-letters/2018.pdf. Accessed 27 Aug. 2020.
(6) "3 reasons most companies are only 20 percent to cloud ... - IBM." 5 Mar. 2019, https://www.ibm.com/blogs/cloud-computing/2019/03/05/20-percent-cloud-transformation/. Accessed 27 Aug. 2020.
(7) "BVP Nasdaq Emerging Cloud Index ...." https://www.bvp.com/bvp-nasdaq-emerging-cloud-index. Accessed 26 Aug. 2020.
(8) "WCLD - WisdomTree Cloud Computing Fund | WisdomTree." https://www.wisdomtree.com/etfs/thematic/wcld. Accessed 26 Aug. 2020.
(9) "DIA: SPDR® Dow Jones® Industrial Average ETF Trust." https://www.ssga.com/us/en/institutional/etfs/funds/spdr-dow-jones-industrial-average-etf-trust-dia. Accessed 26 Aug. 2020.
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