Morningstar Magazine - October/November 2017 - 82

Investors

Castles in the Sky
The winners have emerged
in the cloud market.

SECTOR RAP

Laura Lallos

Cloud computing has been a hot topic for years,
but most companies are still in the early
stages of adoption. As IT workloads shift to the
public cloud over the next several years,
opportunity abounds for infrastructure- and
platform-as-a-service vendors, or IaaS and PaaS,
respectively. However, as explored in a recent
Technology Observer from Morningstar
Research Services,1 only a handful of providers
have the capital investments, research and
development initiatives, and technical knowhow
necessary to predominate.
To learn more about the best investments in this
space, I spoke with lead author Rodney
Nelson. Our conversation took place on Aug. 1 and
has been edited for length and clarity.
Laura Lallos: Many of us are most familiar with

software as a service, or SaaS. How do the platform
and infrastructure as a service markets relate?
Rodney Nelson is an equity
analyst with Morningstar
Research Services specializing
in enterprise software.

Rodney Nelson: The difference between
SaaS and PaaS and IaaS is all about who is
managing which part of the software and
hardware stacks. With SaaS, a single vender, such
as Salesforce.com CRM, manages the entire

software stack, including the physical server, the
database, the operating system, the middleware, the bins, the libraries, and the underlying
code for the application itself.
With PaaS and IaaS, the customer has more
ability to customize. With IaaS, the only thing that
the cloud vendors do is manage the core compute
and storage services. They have data centers
spread across the globe of homogenous hardware
that is providing on-demand compute and
storage technologies for companies to build and
run software on. The beauty of that is the
customer only pays for the amount of compute and
storage that it actually uses, whereas in an
on-premise environment you have to pay for the
cooling, the heating, and so on, 24/7/365.
With PaaS, the stack is a little bit more
controlled by the vendor, who usually dictates
which database technology and middleware
components are used. It's a predefined set of tools
that the customer uses to build a software
application. An example is Twilio TWLO. They've
developed their own programming language
on top of a set of tools that allows a customer
to build a communications application
or build communications function into an
existing application.
You found that industry estimates for the shift to the
cloud in PaaS and IaaS are probably too conservative.

Nelson: One of the more challenging things to
predict in any industry is a secular trend or
a new theme. I don't think many people predicted
that Apple AAPL would have such a rapid rise

in the smartphone market and that the demise
of BlackBerry BBRY would be so quick. That's
the perfect example of how difficult it is to project
exponential growth in certain technologies.
But with the cloud, there's an increasing understanding that running on-premises infrastructure
is a wholly inefficient way to conduct business.
Within an on-premises data center, you're
lucky to extract utilization rates above 10% to 15%.
Within a cloud data center, utilization rates
are up to 95%, so they can spread those costs over
massive customer bases. That's a compelling
reason for enterprises to move into a cloud
environment. They don't necessarily want to spend
less on technology; they want to spend smarter.
Our belief is that over the next five or 10 years,
enterprises will migrate legacy technologies
that run inefficiently, meaning they're only utilized
part of the time or they're built on a very
dated set of technologies. With the savings
generated from that gain in efficiency, they can
invest in more modern technologies like artificial
intelligence, machine learning, the "Internet
of Things," and edge computing. And all of those
services are available in the public cloud. The
public cloud vendors stand to gain a substantial share of the IT budget and tap into a portion
where they never had a presence before.
How long do you anticipate it will be before the
migration is largely complete?

Nelson: It takes a very long time to migrate to the
cloud in totality. Netflix NFLX was a very early
adopter, and it took them seven years to migrate
their entire business from an on-premises
mode to a public cloud model. That speaks
volumes because Netflix is a business that hasn't
been around very long and was already
pretty modern, while some other enterprises
have legacy technologies that date back
30 years. It's reasonable to assume that most
enterprises will take between five and
10 years to get to a steady state where they are
happy with the amount of assets they have
in the public cloud.

1 Nelson, R., Lange, A., Mogharabi, A., Hottovy, RJ, Sun, M., Narayan, H. 2017. "Castles in the Sky: Identifying Moats, Winners, and Losers in the Burgeoning Public Cloud Market." Technology
Observer. June.

82

Morningstar October/November 2017


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