(Note: The author of this fundamental analysis is a financial writer and portfolio manager. He and his clients own shares of GOOGL and MSFT company.)
Cloud computing is a booming industry and is likely to continue growing as faster data speeds such as the fifth-generation of wireless technology (5G) allow companies to move more of their computing power to the cloud. It's clear that the cloud is dominated by two big companies: Amazon.com Inc. (AMZN) and Microsoft Corp. (MSFT). What's less clear is the status of another technology giant: Alphabet (GOOGL). Many estimate it to be a distant third. Each of these companies has seen their total revenue soar in recent years.
Here's a detailed look at the cloud strategies and growth outlook for these three companies.
Amazon Web Services, known as AWS, had the fastest growth in 2018, with total sales jumping almost 50% to approximately $26 billion. Meanwhile, Microsoft and its Intelligent Cloud unit saw its revenue rise by 18% to $32.2 billion. Alphabet, on the other hand, does not publicly disclose its cloud revenue. However, the company did give investors a hint during its January 2018 conference call that its cloud business was a billion-dollar-per-quarter business.
Amazon's cloud business is the second-biggest in the industry behind Microsoft, the undisputed leader. But Amazon depends much more heavily on the cloud for its corporate growth. The cloud represents nearly 60% of Amazon’s total operating income of $12.4 billion in 2018, despite sales representing only 11% of the company’s total revenue. AWS delivered operating income of $7.3 billion in 2018, about 60% more than the $4.3 billion it generated in 2017. Additionally, operating margins grow by almost 400 basis points to 28.4%. This highlights how razor-thin Amazon’s margins are in its core e-commerce business. Amazon’s non-cloud businesses had an operating income of just $5.1 billion, and an operating margin of only 2.4%. It would suggest that Amazon’s future corporate earnings growth depends heavily on expanding its AWS business. Should AWS falter, Amazon would need to find a new growth engine quickly to drive profits for the company.
Microsoft’s cloud growth has been impressive, but the business is part of a more balanced business portfolio compared to Amazon. In it's fiscal 2018 year ending June, the cloud represented 30% of Microsoft’s total $110.3 billion in sales. During 2018, the cloud unit had total operating income of $11.5 billion, which accounted for only 32.8% of its total operating income. Operating margins for the unit were 35.7%, up about 200 basis points from the year prior. Microsoft’s two other units -- Productivity and Business Processes, and More Personal Computing -- represented 32% and 38%, respectively. The lower percentage of operating income may give Microsoft the ability to be more patient with its approach to growing its cloud business. However, Microsoft will need to continue growing cloud sales to avoid total revenue from stalling or slowing too much.
What is clear for Alphabet is that the cloud is not a major contributor to its business and is not likely to be anytime soon -- though the company has big expansion plans. It's not clear how much revenue Alphabet makes a year from its cloud business, but it's possible to gauge how well the unit is doing based on the little information the company has revealed. Using the commentary from the conference call that the cloud generates $1 billion per quarter, it would suggest that the cloud represented nearly 20% of Google’s "other revenue" of $4.7 billion in the fourth quarter of 2017. Regardless of the exact size, it would suggest the business now generates roughly $5 billion a year, representing less than 5% of Alphabet’s total annual revenue. However, Alphabet wants to speed up this revenue growth, and soon. In 2019, the company hired Thomas Kurian from Oracle Corp. (ORCL) who used to run Oracle’s cloud business. The company also noted on its fourth quarter conference call that it hired approximately 4,400 new employees in the quarter, the biggest additions being to cloud sales and the technical teams.
Based on an analysis of these three companies, it's clear that both Amazon and Microsoft increasingly will depend on their cloud businesses to accelerate their earnings and revenue growth. Alphabet, for its part, will be striving to turn its relatively small cloud business into a critical industry player and important contributor to the company's profits. All three of them will have to do so in the face of significant competition.There are other players in the space like IBM Corp. (IBM), Alibaba Group Holdings Ltd. (BABA), and even Oracle that would love to take a big bite out of any of these three companies' market share.
Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past 12 months. Past performance is not indicative of future performance.