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Who Is Ready for the Next Phase of the Cloud?

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

When a company like Microsoft (NASDAQ: MSFT) throws $677 million into a single Iowa data center investors are supposed to cheer and think that Microsoft “gets” the cloud.

Investments like this are, in fact, evidence that companies do not get the cloud, and that they misunderstand the future direction of this technology.

A single large data center can handle virtualization, and it can scale jobs like Xbox downloads to handle demand. But it doesn't provide the one thing most users will soon be demanding of their clouds – redundancy.

By contrast, Netflix (NASDAQ: NFLX) gets cloud. Their OpenConnect software, and their use of Amazon.com resources, are designed to allow both market experimentation and geographical dispersion of resources.

Netflix seeks redundancy

OpenConnect is used to help Netflix store copies of its movies in many different locations, close to consumers. This “caching” of content is almost as old as the Web – companies like Akamai were doing it in the 1990s. By making OpenConnect open source, Netflix assures that it can do this caching on whatever technology platform happens to be available, not just Amazon's.

But depending on Amazon for new business lets the company scale, and close, those businesses at minimal cost. Amazon's cloud is rented, so a company using it for new business gets to close up and walk away, at any point, with minimal cost to itself.

So far this year Netflix has more than doubled in value, to $212 per share, representing a market cap of $12 billion. Its most recently announced quarter, for March, showed year-over-year sales growth of about 20%, and on an annual basis revenues have more than doubled since 2009. Netflix has done all this while keeping debt relatively low, and it presently has enough cash and short-term investments to pay off all its long-term debt at once.

Microsoft has one big basket

Microsoft has also been rising this year, and is presently 25% higher than it was in January. The company carries $11 billion in debt but lists $69 billion in short-term investments on its books.

Year-over-year revenue growth is 15%, and operating margins are back to their normal 33% after taking a dip during the marketing run-up to Windows 8.

Microsoft calls its cloud Azure, and in contrast to systems like Amazon.Com, which offer infrastructure, Azure was designed from the start as a complete platform, with application language support. But Azure has gone nowhere, due in part to Microsoft Windows customers being reluctant to commit to the cloud. 

Microsoft has been left as its own best customer, and the Iowa center is designed to support the next generation of its Xbox gaming system, the Xbox One, as well as Microsoft Office, now being offered as a service and as downloaded software rather than on disk. The company has said it will meet Amazon on price for its base infrastructure, but the success of that venture is not yet clear. 

On the surface, the choice between Netflix and Microsoft sounds like a horses-for-courses debate, with Netflix the choice for capital gains and Microsoft the choice for yield. But the two cloud strategies are radically different, and this could prove important down the road.

Google does it right

Google (NASDAQ: GOOG) has long pursued a strategy more like that of Netflix. The company has many data centers scattered around the globe, and makes copies of itself – or its primary resources – available for delivery to Internet points of presence and to corporate offices around the world.

Because it has redundancy – more redundancy for the most often-used files – Google doesn't suffer long outages like Netflix, which went down four different times last year due to its reliance on a single Amazon data center in Virginia. But, as previously noted, this is a problem Netflix is addressing, and in the right way.

Google is building ahead of the market. It is not yet offering its own full capabilities to the cloud computing market. Redundancy is not a main feature of the Google Compute Engine – instead, resources are held in a single center as close to the customer as possible. But the next evolution in this market will demand redundancy, Google is ready for it, and Netflix is getting ready for it.

Small wonder then that despite its relatively low public cloud market share vis-a-vis Amazon, Google continues to power ahead. Its market cap began exceeding that of Microsoft earlier this year, and now stands at $287 billion – Apple's market cap is less than $100 billion away. Despite this Google manages to grow its top line at 30% year over year, and has expanded its bottom line despite acquiring Motorola last year.

Google is doing all this with one virtual hand tied behind its back. Once it unleashes its full cloud capabilities on the public cloud market, you're going to see some major impacts. This is a stock that needs to stay in your portfolio no matter how frothy it gets, and at a Price/Earnings (PE) multiple of 26 it's pretty frothy.  

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Dana Blankenhorn owns shares of Google. The Motley Fool recommends Google and Netflix. The Motley Fool owns shares of Google, Microsoft, and Netflix. 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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