How You Can Profit From Cloud Companies

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

The software industry is expected to reach to $300 billion this year, 6.4% year-over-year growth, and continue growing to $360 billion by 2016. The spending from small and medium sized businesses, which are expected to spend around 7.1% more on software this year, is driving growth. Due to strong growth potential, companies in this industry are focusing on cloud offerings. The global cloud computing market is expected to reach $121.1 billion in 2015, growing at a rate of 26.2% from 2010 to 2015. Three software companies are enhancing their cloud based offerings with new product launches and acquisitions. Let's discuss them in detail.

Middleware growth and Openstack opportunity

Red Hat (NYSE: RHT) reported revenue of $363.3 million, representing 15.4% year-over-year growth its first quarter of fiscal 2013. Strong traction in its Jboss middleware business propelled the revenue growth. Middleware is software that allows communication and data sharing in distributed applications. Additionally, 60% of its top 30 deals in the first quarter included Jboss middleware components compared to 50% in the previous quarter. Growing demand from the developer community and cross selling to Red Hat Enterprise Linux, or RHEL customers, is driving the additional growth.

The company will extend its Jboss middleware portfolio through last year’s acquisition of Fuse Source and Polymita by offering products like Jboss Fuse and Jboss A-MQ. The company expects a total addressable market of middleware to reach around $17 billion by 2016. The middleware business accounts for more than 15% of total revenue. With increasing use of middleware components, it is expected that total revenue will reach $1.5 billion in fiscal year 2014 compared $1.3 billion in fiscal year 2013.

OpenStack technology presents another significant opportunity to Red Hat with increased adoption of cloud computing. Openstack is an open source infrastructure as a service, or IaaS, initiative to support interoperability between cloud services allowing businesses to build cloud services in their own data center.

In June, it launched an enterprise Linux based OpenStack platform. It is an extension of the RHEL family and provides a way to build both private and public clouds. This increases the usability of OpenStack by making it supportable across multiple systems. Under Red Hat cloud infrastructure, it announced Red Hat Cloudforms 2, a single subscription that provides an open private cloud solution. The company’s OpenStack technology is in its early stage and is expected to generate around $480 million in annual revenue in fiscal year 2015 and beyond.

Services signings and acquisition will drive revenue

International Business Machines (NYSE: IBM) services segment reported revenue of $14.1 billion in the second quarter ended in June, down 4% year-over-year, which was affected by lower margin contracts. However, the services segment will witness revenue growth thanks to new services bookings. In the second quarter, IBM’s services signings were $16.4 billion, showing an increase of 20% year-over-year.

It reported a backlog of $141 billion, reflecting 3% year-over-year growth for the quarter. This is the company’s best backlog growth in the last four years. The growing backlog indicates that clients have signed new contracts or renewed old contracts. The services signings and growing backlog will drive the company’s service revenue in the second half of 2013. It is expected that service revenue will reach $31 billion in the second half compared to $29 billion in first half of this year.

On July 8, IBM completed the acquisition of SoftLayer Technologies, which provides cloud computing infrastructure. The acquisition will accelerate its leading position in cloud computing by increasing business adoption of public and private cloud services. The acquisition will allow the company to integrate public and private clouds for its clients, which will deliver the speed and economy of public cloud while enhancing security and privacy.

The company will form a new cloud division, which combines SoftLayer and IBM Smartcloud into a global platform. The acquisition will accelerate the company’s cloud initiative. IBM’s cloud revenue grew by 80% in 2012 and is expected to reach $7 billion annually by the end of 2015.

Office 365 and Surface price cuts

Microsoft (NASDAQ: MSFT) launched an updated version of Office 365 in February for business users. Microsoft Office 365 is subscription-based online software plus a services suite that provides access to various services and software built around the Microsoft Office platform. Microsoft’s cloud-based offering, Office 365, reported a revenue run rate of $1 billion in April, and it now has a run rate of $1.5 billion per year with increasing customer adoption. The revenue run rate is the extrapolated version of current revenue to determine its full year's revenue forecast.

The company’s Windows division reported revenue of $4.45 billion in the fourth quarter ended in June, down by 5% year-over-year. The fall in revenue was due to the 11% year-over-year decline in PC shipments. PC weakness will remain a headwind in the future due to growing demand for smartphones and tablets.

To overcome that trend, the company is struggling to gain traction in the smartphone and tablet markets. The company reduced the price of its Surface RT tablets by $150; the Surface RT 32GB unit is now priced at $349 and 64GB at $499. The price cut should drive shipments of the Surface RT tablet. It is expected that Surface tablet shipments will reach 3.1 million units in fiscal year 2014, and 5.4 million units in fiscal year 2015 compared to 3.1 million units in fiscal year 2013. 


All these software companies are focusing on cloud service opportunities with initiatives like new launches and acquisition. Red Hat’s middleware growth and long term OpenStack opportunity provides better future prospects. International Business Machine’s growing backlog and acquisition to boost its cloud business will drive revenue. For Microsoft, increased adoption of Office 365 will push top-line growth, and the price cut of Surface RT will increase shipments. Therefore, I recommend all these stocks a buy.

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Madhukar Dubey has no position in any stocks mentioned. The Motley Fool owns shares of International Business Machines. and Microsoft. 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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