The folks at the Motley Fool have been promoting Dave Gardner’s Rule Breakers newsletter for years by using the same basic theme for their ads: Cloud computing scared Bill Gates into retirement, and the “Kings of Cloud Computing” in the next era will make you rich.
If you’re not familiar with Gardner, he’s basically a growth stock investor with a heavy “story” bent — he has a set of “rule breaking” criteria for stock selection that includes picking companies who are “top dogs” and “first movers” in their sector, with sustainable competitive advantage, a stock price that has already gone up dramatically, and a consensus on Wall St. that the stock is “overvalued” or expensive.
Of course, the “cloud computing” ad they’re running has changed a couple times — they’ve revamped the companies they’ve featured/teased a little bit, including offering up a “Kings of Cloud Computing 2.0” last year … but now they seem to have gone back to basics. So what are the stocks they call the “kings” this year, and are they the same ones they’ve pitched before? Let’s check it out and see …
The “hook” for the ad this time is that there’s a mysterious white building that represents this changing world — they show a photo of it, and then open with these enticing quotes:
“At first glance, the mysterious white building in this photo may seem harmless…
“But here are a few things you should know…
“While investigating it, the press likened this monolithic structure — code-named ‘Project 2’ — to, ‘an information-age nuclear plant’…”
Well, that “Project 2” stuff is an old story — actually usually referred to as “Project 02,” Google’s big foray into super-size data centers with a large center in Oregon. It’s sort of part of the “cloud,” but what it was really about was (and is) speeding up search for users, so ads could be faster and search could be more responsive — they’ve built up their own global network of super-fast data centers, which won’t surprise you when you think about the fact that Google search results often load dramatically faster than even a regular web page (like this one) loads on your home computer. They know that if your search doesn’t work in half a second you’re going to be frustrated, whereas here at StockGumshoe.com we rely on your patience as the liquid-cooled hamsters in our server farms do their level best to keep things running.
And yes, they’re still feature Google (GOOG) as the “free” pick in this ad, the one they’re willing to tell you about without you subscribing, and one of the clearer beneficiaries of the web-centered world — not only because of search, and the fact that we’re getting so we have to search the web for everything that our brains have gotten too full to remember, but because of their push of web-based applications (starting with Gmail, but encompassing competitors to all the basic office and productivity software suites) to compete with the desktop apps of old. So David Gardner is saying that it’s not “too late” to buy Google … here’s a brief bit of their pitch, just FYI:
“You see, like Microsoft in the early 1990s, Google is just getting started.
“They’ve already won the search engine war, set the standard for online advertising, and turned the company’s name into a word tens of millions of people use daily.
“And now they’re fast becoming synonymous with the future of computing…
“In fact, over 4 million businesses — ranging from GE to Procter & Gamble to National Geographic — have already signed up for Google Apps.
“This grab bag of business applications can be purchased and run over the Web for just $50 per year and is just one of many Google products now giving Microsoft a run for its money….
“And given its dominance over the online world, massive network of strategic partnerships, and unmatched ability to innovate, you can bet the great majority of the fortunes generated by cloud computing will flow through Google’s coffers.”
You may agree or disagree, of course — Google shares have had a nice recovery since the summer lows this year, arguably in the shadow of Apple (AAPL), but the stock is now just about flat for the past twelve months and trades for only 14 times next year’s expected profit (20X the trailing four quarters of profit). I own both Google and Apple and would argue that both are core holdings for the Internet era, Apple is certainly cheaper and they’re both “big tech” stocks but other than the iPhone/Android competition they’re not particularly comparable (Google is still largely the world’s best advertising company, Apple the world’s best consumer electronic hardware maker and retailer). I expect both of those companies will do very well in the coming years, though Apple will probably provide a more exciting ride.
But what, then, are the two “secret” cloud picks? For that, my friends, we need our clues …
“‘Don’t get caught in this cloud!’
“That dire warning appeared on the first slide of a PowerPoint presentation put together by a well-respected “value” analyst back in June 2009.
“I was in attendance because the company he was urging investors to avoid at all costs had been recommended in Motley Fool Rule Breakers just days prior.
“Now, I won’t bother going into all of the ‘big league’ reasons he gave for steering clear of this stock in favor of more established businesses like Nike, Wal-Mart, and eBay…
“But I would like to quickly tell you why David Gardner and his team were so confident in its potential to hand our Rule Breakers members ‘multi-bagger returns’ — and show you who ended up being right…”Are you getting our free Daily Update
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I don’t know who that analyst was who made the dire, “Don’t get caught in this cloud!” pronouncement … but it wouldn’t be at all surprising that value investors disagreed vehemently with a Dave Gardner pick, thanks to that criteria that this particular Foolie likes only “overvalued” stocks.
So which one is it?
A little more clueishness:
“… unlike any of its competitors, this company guarantees its clients’ applications (think Facebook, Twitter, or YouTube) won’t go down for any reason — making it far and away the most trusted company in the entire industry.
“Of course, as you’ve probably guessed, despite all of the bearish warnings from analysts like the one I mentioned above, this company has gone on to soar an impressive 322% since it was first featured in Rule Breakers.”
And a few specific clues for us to feed into the Thinkolator:
“The company’s most recent earnings report shows that revenue and net income surged 33% and 69%, respectively, year over year — thanks in large part to a 36% jump in total number of customers.
“But that kind of blistering growth is nothing new. In fact, this company has managed to nearly triple its customer base from 53,000 clients to over 161,000 clients in just over 2 years…
“And this marks the sixth consecutive quarter that this company has seen double-digit year-over-year revenue growth…”
Which spits out an answer almost before we’re done feeding it: You dummy! This is one they also teased last time, Rackspace (RAX)!
And so it is. Rackspace looked expensive as hell when they included it in their “Kings of Cloud Computing 2.0” teaser last December, and it’s up 50% since then. And yes, they haven’t just rerun the teaser, they still think this is one of the new buys as of now — or at least, they’ve updated the numbers in the teaser — last quarter really did bring a revenue boost of 33% and a profit increase of 69%, and the 161,000 customers number is the one that Rackspace is using today.
So if you’re looking for growth that Wall Street thinks is overvalued, well, you can certainly get it in RAX — the stock has a PEG ratio of well over 2, meaning that the PE ratio is more than two times the expected growth rate … but it’s worth noting that it had a PEG ratio of over 4 last time I wrote about them a year ago, and analysts have had to up their estimates to keep pace with the rapidly growing earnings stream.
Gardner has made this one of the “core” stocks for the Rule Breakers portfolio, which are the ones that he thinks you should build a portfolio around, so this is certainly a high-conviction pick for them. I have no idea how RAX will do, they are a cloud hosting company as well as a traditional hosting company, with a handful of data centers in the US (and a couple international ones), and their core differentiation in the marketplace seems to be their claim to “fanatical service” and 100% uptime. In the past I’ve expressed my preference for the data center REITs over the data center/hosting operators, in part because I understand the physical asset better than the service, but it’s certainly true that you would have had a hard time beating the performance of RAX over the past two years.
I don’t really understand the competitive advantage of Rackspace over firms like Amazon (AMZN) or Equinix (EQIX), and I do fear the commoditization of “cloud space” as something that could cut into their margins, but they have gotten a lot bigger over the past couple of years (RAX valuation is pretty close to EQIX, just FYI), and they’ve done a good job branding themselves as “fanatical” service providers … and a large, happy customer base can definitely be a competitive advantage in itself.
So that’s one of ’em — how about our third pick for this latest iteration of the “Cloud Computing” tease? Here’s the description:
“The undisputed leader in software for virtual computing
“Much like the last company I told you about, this one has a stranglehold on a niche market that’s absolutely essential to the future of cloud computing.
“But whereas that company provides and maintains the complex hardware that makes cloud computing possible…
“This cutting-edge company designs the extremely intricate software that not only allows these central servers to function in the first place…
“But also allows them to operate at maximum efficiency — which drastically reduces costs for the companies that use them.”
OK … and some specifics?
“industry insiders expect the market for the kind of highly specialized software this company provides to grow to well over $10 billion by 2013 — which is a nearly five-fold increase from 2008!”
Which sounds good, and …
“… according to esteemed research firm Gartner, this company controls as much as 75% of that market!
“So it should come as no surprise that this company managed to absolutely blow away Wall Street expectations in the most recent quarter.
“According to Bloomberg, per-share profits clocked in a full 8% higher than analysts had predicted…
“Meanwhile, US revenues grew 35% and international revenues grew 22%… and service and license revenues jumped 34% and 29% respectively…
“Even more impressive is that despite a generally sluggish economy, this company recently raised its guidance for the remainder of the year.”
So hoodat? Well, believe it or not, this is one from the original “Kings of Cloud Computing” report a couple years ago, VMWare (VMW). The first time this was teased by the Foolies thusly it was in the middle of an incredible share price collapse from around $100 when it started to be spun off from parent EMC to about $20 in the late Summer of 2008, a fall that was driven by fear of competition, management shakeups, possible selling pressure from EMC, and, of course, the general collapse of the market late that year (for a touch of history, EMC bought VMWare in 2003, and took 10% of it public as a spinoff late in 2007 to “unlock the value”).
Apparently many of those concerns were overblown, because VMWare appears still to be in the catbird’s seat as regards virtualization software for servers (that’s what enables a server to have multiple personalities, making for far more efficient use of machines in increasingly crowded data centers). The stock has been trading in a pretty tight range over the past year, but it’s a range from $80-100 a share, so they certainly bounced back nicely from the market bottom.
Interestingly, EMC has not sold off more VMWare — in fact, they have held onto 80% ownership and seem to want to continue to do so, probably for strategic and control reasons. So there are also a lot of investors who like to speculate on EMC if they think VMWare is undervalued — the argument being that VMWare’s value and growth aren’t reflected in EMC’s share price (EMC’s market cap is about $45 billion, VMWare’s market cap is about $35 billion, so you can see that VMWare at its current valuation accounts for more than half of the valuation of EMC). If that’s your argument, that you want to buy EMC because their ownership of VMWare isn’t fully reflected in the share price, do note that even if you’re right you’re not the first person to have this thought … and the folks who bet thusly a year or two years ago haven’t yet seen that thesis proven out in the market — EMC and VMW have not traded in lockstep, but over the past twelve months they’ve provided exactly the same result: a 0% gain. For the past two years, VMW has done almost twice as well as EMC.
And yes, again the stock looks expensive — VMW trades at 33X next year’s earnings, 57X trailing earnings … though, it’s worth noting, analysts are very optimistic about continued growth and their PEG ratio comes in at only 1.5. Which ain’t bad, at least compared to RAX.
So there you have it — the Fool’s favorite three cloud computing ideas are not the same three we saw last time … but they’re close.
For what it’s worth, the same general theme has stayed in place for three years — the most recent push before this, the “Kings of Cloud Computing 2.0” featured these three from today (GOOG, VMW and RAX) as well as Akamai (AKAM) and Salesforce.com (CRM), and previous iterations beginning in 2008 were largely focused on Google, VMWare and Akamai … with a big push for Akamai more often than not, so perhaps the biggest change has been AKAM getting pushed off the bridge (for good reason — I also suggested AKAM in the Summer of 2009 but thought it was time to take profits when it recovered into the high-$40s a while back).
So what do you think? Are GOOG, VMW and RAX your top picks for your “cloud computing” cash, or do you have better ideas to play the trend? Or do you think this is all foolishness? Let us know with a comment below.