Who Gets Hit in the Cloud Hangover II?

Dana is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A recent comment on another story recently offered me some sound advice in looking at cloud companies:

All cloud companies are software companies, but not all software companies are in the cloud."

The intent of cloud designers is to abstract as much of computing's complexity as possible to software, and then run that software on commodity hardware. Virtualization is one step, allowing a computer to run programs on multiple operating systems. Distributing computing is the next step, allowing jobs to be passed around as many computers as needed to get them done in parallel.

The result should be a cloud infrastructure that enables a new form of computing, one that can be scaled instantly to the job at hand, and that can run on any hardware. This is followed by creation of a platform, a set of tools needed to build the real goal of the cloud, applications.

Google was the first cloud application. Many of the techniques resulting in the cloud were pioneered by Google, in its race to keep its costs as low as possible. But Facebook is also a cloud application. So is Yahoo. So is Amazon.Com.

The question for investors, now that the hype of the cloud has passed, is how do we identify those companies that are long term winners in the cloud, and put money to work in them as they fall to Earth?

VMW: Betting on the Jockey

VMware (NYSE: VMW) has had the proto-cloud software lead for years with its vSphere virtualization system. The vSphere system is the leading hypervisor on the market, and a hypervisor is the software tool you need for virtualization.

So it is that VMware, which is 80% owned by EMC (NYSE: EMC), a hardware company selling data storage units to cloud providers, had the early lead in cloud, and a big place in the cloud hype cycle.

But VMware stock has been a victim of the hype cycle it helped create. It peaked at nearly $115/share last summer, and fell hard on a January earnings miss. It's currently trading at a little over $75/share.

Should you play VMW?

Well, the key point to know here is that with VMware, you're betting on a jockey. Specifically, you're betting on Paul Maritz. Maritz, a former Microsoft executive, led VMware as a partial spin-off, but he's no longer the man in charge. That's Pat Gelsinger, a former Intel executive.

Maritz has moved to parent EMC as chief strategy officer, where he is heading something called The Pivotal Initiative. This combines assets from both VMware and EMC, into some new organization.

That organization was announced last month. It will be 69% owned by EMC, 31% owned by VMware, and focus on the big data opportunity, using tools that mainly come from VMware, and cash from EMC. Maritz will head it up.

All of which tells me that, if you like the concepts behind this launch, you want to be in EMC. You'll get more shares in the new company, and can transition to it by selling your EMC stock after the spin-off.

VMware is going to be left as it is, a profitable virtualization company milking its niche. It will have a 31% share in a real cloud software company, but why pay a premium for that when you can get EMC shares for half that price?

Even if you're in VMware now, it makes sense to sell out your position and move over to EMC as soon as you can. The Pivotal Initiative is going to be the company's cloud software play, and that's where you want to be. If you're betting on Maritz as a long-term cloud leader, and he's been a good jockey so far, that seems like the play.

Citrix: Do the Pieces Fit?

Citrix (NASDAQ: CTXS) did not start out to be a cloud company. It's best known for PC access products, like the heavily advertised GoToMeeting and GoToMyPC.

But Citrix has a cloud strategy, and it's an interesting speculation.

The strategy is built around a hypervisor called Xen, an open source hypervisor that Citrix re-sells. The company wants to extend this into a virtual CloudPlatform, also open source, organized under the rules of the Apache Foundation.

According to its Product Matrix, and its press statements, Citrix hopes to be a “Switzerland” among competing cloud infrastructures, primarily those of Amazon and OpenStack. It is offering the software both to operators of public clouds and those building private clouds. It claims its stuff is better.

Whether it is or not, success depends on building a channel for its cloud offerings, a network of experts, and organizations, dedicated to re-selling and supporting Cloud Platform.

And that's where the speculation comes in. You're betting that Citrix will be one of the survivors in the cloud infrastructure wars. Personally, I don't see it. I know Amazon has the current market share, so companies that support it directly, like privately-held Eucalyptus, have an opportunity. Much of the rest of the power in the space is lined up behind OpenStack, an open source operation with its own foundation behind it. This includes IBM, by the way. Then you have VMware and its Pivotal Initiative. And then you have Citrix and Apache Cloudstack.

I may be wrong, but to me it doesn't fit. Worse, I don't see much visibility on that going forward – Citrix is no more likely to break out its “cloud” revenues than is Amazon, in other words it won't. What you're betting on here is that the company can continue to profit from its existing products and draw enough buyers and builders into its CloudStack to make a success of it.

The company has executed well, growing over 37% from 2010-2012. But profit margins are a little dicey, and you have to wonder how much further the old products have to go. Sure, they could be sold through a Citrix cloud, and it's applications, not operating systems, where the real money will be in cloud at some point. But that hasn't happened yet.

I have to call it iffy.

Take Care

If you have read my first two hangover stories, you have a few clues as to the nature of the cloud. It's about the software, it's about gaining visibility on customer wins going forward, it's about being part of something bigger than your own operation.

At current prices, I find both VMware and Citrix to be fairly speculative, not my first choice for the cloud. I feel a little better about VMware, because I have faith in Paul Maritz, but neither is my first choice.

But if you're interested, look closely. They might become yours. And if they do, please drop me a note and tell me why.

Dana Blankenhorn has no position in any stocks mentioned. The Motley Fool recommends VMware. The Motley Fool owns shares of EMC and VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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