Perhaps the biggest technological change of the current age is the massive shift of enterprise IT spending to the public cloud. The public cloud offers numerous benefits to companies, saving costs by eliminating the need to buy and manage one’s own infrastructure, offering the ability to scale up and down as needed, and providing continuous access to the latest storage and computing technologies.
According to research firm Canalys, the global cloud infrastructure-as-a-service market reached $31 billion in the first quarter of 2020, or a $124 billion annualized run-rate, and growing a whopping 34.5%, even in a pandemic-fueled quarter. That’s a massive growth rate for an industry that big, and is also why the leading cloud stocks are some of the best opportunities for the long-term Foolish investor.
If you’re looking to play the cloud revolution in August, here are a few of the best-looking bets in this red-hot sector right now.
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Cloud Computing: Microsoft
Of the big three U.S. cloud companies, Microsoft (NASDAQ:MSFT) grew the fastest in the June quarter, with its Azure cloud infrastructure segment growing a whopping 47%, or 50% in constant currency. Yet besides Microsoft’s strong No. 2 (and gaining) position in the cloud infrastructure market, the company also has numerous other business segments primed for more profitable growth. One notable segment is the Xbox segment, which is coming out with the first new console in seven years this holiday season. Xbox grew a whopping 65% last quarter as people bought up video game hardware and software in quarantine, even though the new console isn’t even available yet.
Of course, the big news of recent days has been Microsoft’s involved talks to acquire the U.S. operations of Tik Tok, the short-form video social media juggernaut from Chinese unicorn Bytedance. However, just on Thursday, it was reported that Microsoft is now looking to buy all of Tik Tok’s operations outside China, which could be a massive deal.
It was getting hard to picture how Microsoft could continue to add new incremental growth given its already massive size, but adding a leading social media company could do that very thing. According to Oberlo, Tik Tok has been downloaded 2 billion times and counts 800 million active users, and the average user spends 52 minutes per day on the platform. That could be immensely valuable for Microsoft while also giving it access a younger demographic. As a shareholder, I’m hoping a deal is reached (at a reasonable price, of course).
Cloud Computing: Tencent
Chinese tech giant Tencent (OTC:TCEH.Y) isn’t often counted as a cloud computing stock, but the massive Chinese tech conglomerate is making a big push in this area. For a long time, rival Alibaba (NYSE:BABA) was the far-and-away leader in cloud in China; however, Tencent has been investing heavily in its cloud capabilities over the past few years, and those efforts appear to be bearing fruit.
During 2019, Tencent increased its Chinese cloud market share from 15.4% to 18%, while Alibaba’s fell from 47.3% to 46.4%. Additionally, a recent Reuters report disclosed that Tencent is now winning as many high-profile government cloud deals as Alibaba these days.
While cloud accounted for only 4.5% of Tencent revenues last year, it could grow a lot in the years ahead. According to Canalys, China’s cloud infrastructure-as-a-service market grew 67% in the first quarter of 2020. Not only that, but cloud could also allow Tencent sell more software-as-a-service over its infrastructure to Chinese customers, such as Tencent Meeting, which is essentially a Zoom competitor in the Chinese market, and which saw usage take off in a big way during quarantines.
Given the strong growth of the Chinese cloud industry, Alibaba could be a strong choice too; however, I like Tencent’s overall business across online games, social media, streaming video, and payments as well. And by the way, Tencent owns large minority stakes in both JD.com and Pinduoduo, which are giving Alibaba stiff competition in Chinese e-commerce, and Tencent has proven to be an outstanding investor in other companies besides these two as well. Looking at the whole picture, Tencent still looks like a great buy even after its strong 2020 run.
You may notice I don’t own Tencent outright, but I do own Alibaba. That’s because I own both Naspers (OTC:NPSNY) and Prosus (OTC:PROS.Y) in larger quantities, each of which owns large stakes in Tencent and which trade at a large discount to the value of that stake.
Cloud Computing: Dell Technologies
Speaking of wacky discounts, Dell Technologies (NYSE:DELL) might not seem exactly like a cloud titan, but it serves the main cloud providers in many ways. It’s one of the leading providers of cloud data center servers worldwide, and also sells customized, tightly integrated sets of its server and software within its Dell Technologies Cloud modular offering.
Through its 2016 acquisition of EMC, Dell also acquired EMC’s majority stake in VMware (NYSE:VMW). VMware sells a suite of virtualization tools that allow enterprises to manage multiple clouds, as well as their on-premises infrastructure, all within one a single pane of glass. That company also acquired endpoint security software company Carbon Black last year, which helps secure cloud operations as employees access the cloud from the enterprise perimeter.
Dell is interesting right now because it just announced its intention to potentially spin off its majority 81% stake in VMware, which itself is publicly traded. While a transaction won’t happen until September 2021, since that’s when a spinoff could become tax-free, it could unlock serious value.
Right now, Dell’s 81% stake in VMware is worth about $49 billion, while Dell itself has a market cap of only $45.1 billion. That means the market is valuing the rest of Dell at negative-$4 billion! Needless to say, that’s a strange phenomenon. While Dell’s server and client businesses aren’t really growing and the company does have a fair amount of debt, that remaining stub doesn’t have negative value.
For patient investors, it appears that taking a stake in Dell could still allow one to benefit from a financial engineering scheme next year. While that is a next-year story, who knows where the market will trade Dell stock in the meantime? Interested investors should therefore look at this special situation and value stock today.
Billy Duberstein owns shares of Alibaba Group Holding Lt