Big Names Enter Cloud Computing

By Arthur Pinkasovitch - February 10, 2012 | Tickers: ORCL, CRM, SAP, SFSF, TLEO.DL | 0 Comments

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Cloud computing services have emerged as an ideal alternative to traditional enterprise networks, offering superior performance and enhanced security features. With increased support of cloud computing services, businesses are able to cut expensive hardware and software costs and take advantage of enhanced product flexibility. Another primary advantage of cloud computing is that information can now be easily accessed remotely from outside the office through almost every internet-connected device, be it computer, tablet or even smartphone. Cloud computing introduced a number of key advantages into the corporate landscape including: ready access to stored data, decreasing enterprise hardware costs, fewer software licenses and even a reduction of physical space requirements to hold servers.

According to estimates by Gartner, the size of the cloud computing market will reach $150 billion by next year; this figure is comparable to Merrill Lynch’s estimates of $160 billion. As corporations realize the benefits of these services, 60% of server workloads are forecasted to be virtualized by 2014, a staggering increase from the 12% figure realized only three years ago. Moving over to the cloud allows managers to focus their human capital resources on more profitable business segments without concern for physical server maintenance and continuous company-wide software updates.

Traditional software companies have recently started making a push toward the cloud computing bandwagon, marking a shift away from the established enterprise software/hardware model. In a major move Oracle (NASDAQ: ORCL) recently agreed to purchase a maker of cloud-based human resource software, Taleo (UNKNOWN: TLEO.DL), for $1.9 billion. Forrester analyst Paul D. Hamerman said of the deal, “Larry Ellison used to be quite vocal that this sector would not be very profitable, but he’s changed his tune because customers prefer the Web for certain applications.” The number of cloud-related M&A deals has soared, increasing by 59% to $9.7 billion in 2011. The most recent Oracle deal, following its $1.5 billion acquisition of RightNow, intensifies the competition in this space as Ellison vies with his rival SAP (NYSE: SAP), which recently agreed to purchase SuccessFactors (NYSE: SFSF) for $3.4 billion. SuccessFactors is a rapidly growing provider of business execution software.

Major initiatives aimed at advancing their cloud computing presence could not be delayed any further, in light of the growing success of the new business model. Figure 1 below shows the standardized sales growths of Oracle and SAP, compared to Taleo, SuccessFactor and Salesforce (NYSE: CRM), the behemoth of cloud computing, over the last five years. I chose a five-year time period because the smaller-growing cloud players had established their operations outside of their initial growth phase. Since SucessFactor obscures the data with its 15.3x revenue increase, Figure 2 omits this company’s results. A quick glance at the comparable growth rates between the well-established Oracle and SAP and the cloud computing players quickly reveals the high level of exceptional growth of salesforce.com and Taleo. Oracle’s and SAP’s recent round of acquisitions is intended to capture some of this revenue growth for the otherwise mature industry of traditional enterprise software business.

Figure 1: Standardized Sales Growth

Figure 2: Standardized Sales Growth

Previously, Oracle (and SAP) avoided mergers with cloud computing firms in order to protect their high margins. Oracle and SAP operate with solid EBITDA margins of 43.4% and 39.4%, respectively. Taleo and SuccessFactor, on the other hand, support weak EBITDA margins of 6.0% and -11.4%. Even salesforce.com, which is a well-established name in the cloud computing business, operates with a low EBITDA margin of 5.3% (see figure 3). The ongoing costs of running and maintaining data centers are significantly greater than the basic costs of providing traditional software-related services. Reservations regarding entering the cloud computing business stemmed from corporate concerns of reduced business margins; however, the stellar top-line growth and more importantly, the shifting consumer preference, have outweighed the disadvantages and forced big name companies to enter the cloud business to ensure that they do not go the way of Blockbuster when it failed to compete with Netflix in the dynamic movie rental business.

Figure 3: EBITDA Margins

The growth in cloud computing has attracted such big name customers as Siemens, Starbucks, Qualcomm, Dell, NBC Universal, Canon, Dr. Pepper Snapple, Sprint, Kelly Services, Avon, Atmos Energy, Ally Bank, ADT Worldwide, American Red Cross, Cisco, E*Trade, Hewlett-Packard, Motorola, Phillips, Google and Toshiba (all of whom are salesforce customers). Although cloud computing originated in the early '90s with small operations at salesforce.com and Netsuite, the business started to gain real traction in 2009 as safety issues were addressed and a growing number of customers realized the appeal of the cloud. With deep pockets and significant leverage power, Oracle and hardware providers such as Dell are predicted to participate in a growing number of M&A deals within the next few years.  

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