Cloud Computing Infrastructure: 2 Stocks to Consider

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

Cloud computing is showing tremendous growth. Consider Apple (NASDAQ: AAPL) as it has moved its music offerings as well as backup of iPhones and iPads to the cloud. As Apple has expanded its content offerings more and more server farm space is needed to accommodate the huge need for ever expanding data.

The whole idea behind cloud computing is to use computer processing power and storage capacity remotely. Besides Apple, all the leaders on the Internet have major operations using cloud computing including Google, Facebook, LinkedIn and the list goes on.

The trick now is to look at companies providing infrastructure services for cloud computing. These "pure-play" companies will never seem cheap in terms of valuation, but the hope is that with the increasing growth their valuations will someday catch up.

Rackspace Hosting (NYSE: RAX) is a company based in San Antonio, Texas that offers infrastructure and hosting for cloud computing services. They sell their cloud hosting services through an open platform system called openstack mainly to small and medium sized businesses. The revenue growth for this company has been impressive, growing at >30% a year in terms of revenue and according to analyst estimates the growth may exceed 40% this year. The competition in the space is fierce, but Rackspace has held its own by continuing to grow the number of customers it serves, the number of servers it operates and the average monthly revenue per server. We are talking a bona fide growth story, but one that has been recognized by Wall Street, since the stock is up more than 70% in the last year.

The main risks are valuation with a PE ratio of over 100 and being able to maintain the current growth rate. The business is capital intensive and all that investment cuts into profitability so their free cash flow is not as impressive as it could be.

A competitor of sorts to Rackspace is Equinix (NASDAQ: EQIX). This company arranges for the facilities used by cloud computing companies by arranging for turn key server farms ready to be used by companies to provide cloud computing services. Equinix is more of a real estate investment trust and has filed to become one in 2015. Just like Rackspace it is growing rapidly in the space and also sports a very high valuation with a PE ratio over 90.

One of the attractive features of both these companies is that they are both midcap stocks with market capitalizations around $9 billion or so. They are both involved in a very high growth sector with the potential to double revenues in just 3-4 years. If you are looking at pure play leaders in this space I would consider both of these companies. A big player that competes with these two names would be Amazon (NASDAQ: AMZN) who does provide cloud computing services and is revolutionizing the space by offering services in very small chunks. But alas even though Amazon is being valued just like a cloud computing pure play, its main business is online retailing which in itself carries much smaller margins. Another company to watch out for is Facebook (NASDAQ: FB), since they build out their own data centers, and at some point may go the way of Amazon and rent out some of their extra capacity thus putting their tentacles in a high growth space.

Overall, this is a very exciting growth area with lots of companies using cloud computing services. The real money is to be made in those companies that enable cloud computing by providing infrastructure services. The main risk now is the valuation fo++r these companies.

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Fool blogger, Erick M. Santos, M.D., Ph.D. owns shares of AAPL, RAX, EQIX and AMZN. He does not own shares in FB. The Motley Fool owns shares of Apple, Amazon.com, and Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Amazon.com, Apple, Facebook, and Rackspace Hosting. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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