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Capital IdeasTM

Investment insights from Capital Group

Categories
Equity
Investing in a cloud-powered world
October 13, 2021

The cloud is powering the fourth industrial revolution


Each industrial revolution has had a catalyst followed by transformational change. Steam enabled mechanisation in the first industrial revolution, electricity led to mass production in the second, while technology drove automation in the third.


The cloud’s transformational power gives it the potential to rewire the global economy and be the catalyst for the fourth industrial revolution.


 


The future of data


Around the world, more than 300 billion emails are sent and received every day.1 Elsewhere, a single autonomous vehicle produces about five terabytes of data every hour.2


As our digital data continues to grow at a rapid pace, storage management will become increasingly crucial. While the cloud provides a great solution for data storage, its true potential comes from how the huge amounts of data are analysed and used in a collaborative manner to deliver insights and drive innovation.


We are already seeing the tangible application of data mobilisation in apps like Google Maps. Map co-ordinates, satellite images, photos and data are all stored in the cloud, but the real potential only emerges when an artificial intelligence engine integrates, analyses and synthesises the layers of data and images into usable output.


“With large datasets and compute capacity, machines can learn how to pre-define algorithms better than humans… and the cloud enables that,” says equity investment analyst Julien Gaertner.


 


Ways to invest in the cloud


The implications of the democratisation of data and enablement of cloud technology are vast. So, how do you structure exposure from an investment perspective?


We have identified opportunities along the cloud value chain framework, which breaks down cloud technology into three layers.


DSK chart

Source: Capital Group


1. Enablers


We are already in the midst of the transition to the cloud. As we see broader migration and adoption, there will be higher demand for the components driving these processes. And as the cloud supports more complex computation and analytics, there is greater demand for higher performance components.


Semiconductors – an attractive industry structure


It’s difficult to overstate how important semiconductors have become to the global economy. They are needed in everything from data centres and smartphones to cars and washing machines.


While the semiconductor industry’s customer base has expanded, the number of industry participants has consolidated. Today the semiconductor industry has only a few dominant players. Essentially an oligopoly, it is an industry that has demonstrated steady growth, high margins and lower cyclicality. This is a solid set of underlying fundamentals for long-term investment opportunities.


Components


As cloud unlocks greater functionality, more industries and markets will make the case for more devices connected to the cloud. In turn, this increases the need for more components, sensors, connectivity, and storage capacity.


There are several areas in the component space our analysts find particularly interesting. In each area, specialist technical knowledge helps to understand each sub-market and the specific growth dynamic.


 


2. Solutions


We’ve covered the hardware components from which the cloud platform is constructed; the next stage looks at the companies that deliver cloud technology as a solution to users.


We divide solutions into two categories: i) infrastructure providers and ii) software providers.


Infrastructure providers


Cloud infrastructure is fairly familiar territory. It includes well-known names such as Amazon’s AWS cloud services, which has 33% of the market, Microsoft Azure with a 20% market share and Google Cloud Platform with 9%.3 These companies have built a dominant market presence by expanding their product offering and reaching more clients. This continued dominance could offer compelling investment opportunities – while the COVID pandemic has accelerated the shift to the cloud, there is still a potentially long runway of secular growth for the dominant companies.


There are also pockets of regional growth. In China, Alibaba and Tencent currently only have 6% and 2% of the global market share, respectively.4 However, cloud adoption in China is behind other regions and the government’s ambition to catch up is leading to a much steeper growth trajectory. The initiative from the Chinese government is focused on the cost of transition, paying up to 100% of the costs for small- and mid-sized businesses to migrate to the cloud.


“China is behind in adopting cloud computing but COVID accelerated this trend. The path of adopting might be different from the US with mobile-related usage a key area of growth,” says equity portfolio manager Winnie Kwan.


There is room for global cloud infrastructure providers to catch up with the US


Public cloud spending worldwide (US$ billion) and annualised growth rates (2020-2025)


DSK chart 2

Forecasts shown for illustrative purposes only.


Data as at June 2021. Source: IDC, ‘Worldwide Public Cloud Services Spending Guide’


Software providers


If infrastructure is known for its oligopolistic nature, then software could hardly provide more of a contrast. There are over 20,000 software-as-a-service (SaaS) companies4 globally but less than 1% of them are valued at more than US$1 billion5.


The very nature of the cloud – as an analytics and delivery platform – is the cornerstone of the SaaS busines model and underpins its high profitability. The lack of hard infrastructure and low marginal cost for additional subscribers are key to the very high margins in the industry.


The potential for enhanced returns in this area does, however, mean it is a crowded marketplace. Companies ranging from established incumbents to innovative start-ups have the ability to be very successful if their products can gain traction among users. This makes the industry dynamic and exciting but also highlights the need for deep fundamental research to pick the ultimate champions.


There are two key ways to capture significant market share in software. One is to specialise in a particular industry or sector and serve that market end-to-end. The other is to provide a package with features that serve customers across a wide variety of industries.


 


Looking ahead


The cloud’s power spans data storage, distribution platforms, big data analytics, machine learning and artificial intelligence. Identifying different investment areas within the cloud value chain can help more effectively flag the opportunities and risks for companies positioned to harness the power of the cloud.


1. The enablers, who are key in providing the mechanics that power the cloud’s existence.


2. The solution providers who can unlock the power for users to access data platforms and analytics


3. The beneficiaries who are harnessing the cloud to disrupt industry and create powerful growth potential.


The broad applications of cloud technology that mean it can be the lifeblood of the future global economy.


 


 


1. As at February 2021. Source: Statista


2. As at January 2020. Source: Dell Technologies (connected car is measured as a car “under task per hour”)


3. As at July 2021. Source: Synergy Research Group


4. As at 31 March 2021. Source: Crunchbase


5. Total number of SaaS companies valued above US$1 billion is 140. As at 31 March 2021. Source: Capital IQ


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