Is the Cloud the New Way to Go?

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

"Cloud computing" refers to delivering hosted services over the Internet. Data and software packages are stored on servers, allowing employees and others to access the information remotely and modify data in real-time. This can trim both costs and time for companies, but it also creates a certain dependency on the vendor of the cloud service.

Although this market has been developing for a long time, the last few years have experienced a steep expansion in cloud services and has hurt some of the traditional hosting services companies. Some companies have seen a decline in revenues in those traditional hosting services (client-service) and are now trying to keep up the pace in this important race towards cloud computing. Gartner estimates that by 2015, companies in the consumer technology space will spend about one-third of their budgets on digital campaigns.

Expensive acquisitions

One of those companies is International Business Machines, better known as IBM (NYSE: IBM). Last week, IBM paid $2 billion for SoftLayer, a private company that claims to be the world's largest cloud computing infrastructure provider. This was an expensive move for IBM as SoftLayer had revenues of $335 million in 2012 and the deal values SoftLayer at approximately 11 times its estimated 2013 earnings before interest, axes, depreciation, and amortization. This shows that IBM has some margin pressure due to the fierce competition in the cloud services market and will have to adapt to the new environment or lose customers to competitors. The company expects to reach $7 billion in cloud revenue by 2015.

Also last week, Salesforce.com (NYSE: CRM) acquired ExactTarget (NYSE: ET) a leading cloud marketing platform for $2.5 billion. This is another expensive acquisition as Salesforce is paying about nine times ExactTarget’s 2012 revenue of $292 million. This indicates a strong bet that cloud companies are making for the future. Moreover, ExactTarget is yet not profitable: in the last year it lost $21 million and in 2011 it lost $35.4 million. Salesforce is trying to take advantage of the marketing revolution created by the increase in use of mobile devices and social networks that are reshaping budget allocations towards digital marketing campaigns.

Another company that is struggling to get a piece of the cloud pie is SAP (NYSE: SAP) which will acquire Hybris, a Swiss company focused on online management and logistics software. The companies will blend quite well as the SAP can add it to its already existing portfolio of human resources, payroll and e-commerce tools. The price of the acquisition has not been disclosed yet but different sources estimate it at around $1 billion. This would value Hybris at 10 times its annual revenue of $110 million, which at first seems a really expensive price tag. This acquisition goes in line with SAP’s strategy of maintaining its current customers and expanding its cloud services.

CRM: Competitive market

The CRM (customer relationship management) market is becoming a fierce arena. This is why some companies such as IBM, Salesforce and SAP are willing to pay a premium for acquisitions as they shift towards cloud computing services. The demand for cloud services is increasing and companies need to be prepared for those changes. In 2012, Salesforce was the leading company with 14% of the CRM market. SAP was in second place with 12.9%, while IBM was far behind with only 3.6%.

How will these acquisitions impact each company?

IBM’s acquisition of SoftLayer will help it offer cloud services to more than 20,000 customers. SoftLayer mainly small and medium-sized businesses, which will give IBM a wider scope of offerings as well as access to smaller customer segments. The acquisition will also help IBM reach its goal of $7 billion in cloud revenue by 2015. It is also important to note that SoftLayer offers shared or dedicated services, a hybrid that provides the desired flexibility demanded by customers. Although expensive, the acquisition does not represent much for IBM’s balance sheet.

Salesforce will benefit from the acquisition of ExactTarget as the latter provides services to the marketing departments of companies, a segment that Salesforce has been directing much of its attention to lately. Companies use ExactTarget software to plan marketing campaigns; as that is what Salesforce was looking for, the companies should complement each other perfectly. Salesforce is paying a high price to expand its market share in the digital marketing sector, however. The negative aspect that Salesforce has to review is the offering of a public cloud service, as customers must rely on the company’s infrastructure and it has less portability than IBM, for example.

SAP’s acquisition will help the company to reinforce its e-commerce segment and help the company battle for the CRM market that is currently dominated by Salesforce. Its strategy is focused on providing other companies with all the tools that they need to strengthen their relationships with consumers. Hybris has proven to be a expensive target for SAP, but it will help the company to provide a new range of services that it did not have and better position the company for competition from IBM and Oracle. SAP has stated that it will run Hybris as a separate company, posing the challenge of retaining the top talent of the newly acquired party which may be a difficult task for the German firm.

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Vanina Egea has no position in any stocks mentioned. The Motley Fool recommends Salesforce.com. The Motley Fool owns shares of International Business Machines.. 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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