Tuesday, January 25, 2011

Cloud providers and software vendors aren't a great long term bet

I'm noticing a bunch of cloud providers attracting massive numbers for funding and people are talking about mega-billion industries and everyone getting hugely rich.

I'd like to sound a note of caution, not on the concept that cloud is important or not going to happen but on the concept that there are loads of companies that are going to make loads of money on it. Let me tell you a quick story about a company that believed in Telecoms in the late 20th Century. The company was called GEC and was one of the giants of UK industry. A GE of the UK with a very strong defence arm. The company had billions in the bank and was one of the most solid stocks in the FTSE 100. Now this company had some new leaders who loved the idea of Telecoms and its "better multiples" and wanted to get out of that boring, profitable, defence industry and go heavy into Telecoms. In 5 years from 1997 till 2001 these new leaders invested all of the cash pile, sold off the defence arm and turned a once towering industrial into a bankrupt shell.

How about another? Lets take Vodafone and their stock chart across this Telecom bubble.

Want another? Alcatel Lucent. Note here I'm talking about two companies who survived the bubble as well as one huge company that bit the bullet as a result of it. One that never recovered would be Nortel a company that during the bubble was at one stage worth 1/3 of the total value of Canadian companies! Startups like Winstar were allegedly worth over $4bn but went pop within a year. Throw in AOL's merger with Time Warner and the picture is pretty complete of massive over investment in infrastructure providers and technologies with a view that the market was basically infinite.

This isn't the first time that an infrastructure play has fundamentally failed to make long term money. Roads, Rail and even Canals had their own booms and bust as it became clear that it was too expensive to build all that infrastructure which people fundamentally didn't want. This is really true in something like Telco, and the cloud, where fundamentally the cost of provision is being driven relentlessly downwards. Investing $10bn today in IT infrastructure is like investing $2.5bn in 4 years time, in other words your investment is worth 1/4 of its retail value in 4 years. Even today with the boom in Mobile Internet you could argue that the large providers aren't massive growth stocks but instead are acting as traditional infrastructure providers and many aren't back to their peak of ten years ago.

So what does this mean for cloud? Well this is another infrastructure play. SaaS and end user provider pieces like Facebook are different types of companies but cloud companies are fundamentally about infrastructure so there are a couple of things to note

1) Its probably too late to get in at the ground floor with startups, although a few will do a spectacular growth and pop
2) Its still worth getting into a cloud startup
3) Start looking for the exits when you compare your company with a "dull" company and think "hell we could be worth as much as Wallmart soon"... that is the time to jump

Stock and investment wise its fine to ride the wave that these companies represent as we should never avoid making money from the up-curve of a bubble.

In the long term its a Telco model ala Vodafone or AT&T so expect the big investments from Microsoft, IBM and Amazon to yield minor returns initially but provide a long term steady income but at the sort of levels that would make people just hold onto the cash if they sat back and thought about it.

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