MARKET VIEW
Hybrid cloud gains traction as more enterprises embrace a multi-cloud strategy. Enterprises are gearing towards a mix of on-premise, private and public cloud (also called hybrid cloud) as it offers flexibility and scalability. Such a multi-cloud strategy will help to prevent vendor lock-in and allows enterprises to have greater control over their infrastructure. More firms are migrating workloads to public clouds while upgrading their IT systems to create a seamless pool of resources across the businesses’ premises and cloud. This approach helps the firms to minimise disruptions by gradually moving to a cloud-based IT infrastructure at their own pace. Compliance assurance will also continue to play a major role in driving hybrid cloud implantation as a sizeable number of countries still require localised data centres.
STRATEGY
Our Cloud Capital Expenditure (Capex) indicator* signals a moderation of cloud spending growth in 2019. Weaker spending in the past 3 quarters (Figure 1) points to a deceleration of 33 points from 53% to 19.9% from Q1 2018 to Q4 2018. The deceleration is likely to last into 2H 2018 as companies digest the excess memory purchases in 1H 2018 and the strong capex from Q2 2017 to Q1 2018. Therefore, we expect a total annual capex growth to soften by 17.7 points from 43.9% to 26.2% in 2019 (Figure 2).
Reported capex guidance of hyperscale cloud service providers (CSPs), component vendors showed mixed signs of cloud capex slowdown. Microsoft reported capex of $3.6B in CY3Q, which missed the consensus estimates of $3.783B. Microsoft expects capex growth rate to moderate for the rest of its financial year even as it meets demand for cloud services. Meanwhile, Facebook softens its capex expectations from $15B to $14-15B. Facebook also expects 2019 capex to be $18-20B, which points to a 33% YoY growth in 2019. Amazon reported capex of $3.35B in Q3 2018, which meets consensus estimates. Google showed increased capex of $5.28B against consensus estimates of $4.98B.
Component vendors also reported a pullback of customer demand. Seagate (STX) signalled a weaker cloud demand in 3Q 2018, which is compounded by the weak China enterprise segment demand. It expects growth to resume after 2019. Western Digital’s latest results on 24 Jan 2019 echoed STX’s view as there was a 21% YoY decline in revenue to $4.23B, missing consensus estimates of $4.26B. The decline was due to a weakening in NAND flash prices and demand of hard drive exabytes.
The recent slowdown is only temporary as global pipeline remains strong for data centre REITs and networking. Despite the anticipated slowdown by component vendors, infrastructure pipeline projects growth remains positive for hyperscale, networking and data centre REITs. Data centre REITs such as CyrusOne (CONE) and Digital Realty (DLR) continue to see 7% YoY growth in capacity bookings for 3Q 2018. CONE indicated a record total monthly recurring revenue (MRR) signed from CSPs. Revenue from the IT-Cloud sector contributed 38% to its total revenue in 3Q 2018, as compared to 17% in 3Q 2017. DLR, whose primary business model focus on hybrid cloud a.k.a. co-location, noted a similar trend as its top 20 customers (which are mostly cloud service companies) represent 53.2% of its annualised base rent (ABR). Both REITs continue to expand its data centres, with CONE co-developing a data centre in Netherlands and DLR entering into a joint venture to acquire Brazilian data centre giant Ascenty, which has the largest market share in Brazil. On the networking side, Juniper highlighted that some of its customers might have higher utilisation for networks, while Arista noted strength in capex spending for early 2019 in the two-quarter visibility.
CSPs are committed to expanding their data centres, though timing is mixed.
These events indicate that there is still strong momentum for data centre spending despite the recent slowdown. According to the IDC Worldwide Semiannual Public Cloud Services Spending Guide, overall spending on cloud IT infrastructure will grow at an 11.7% CAGR and by 2020 will surpass spending on non-cloud IT infrastructure (Figure 3). It is estimated that 53% of the total IT infrastructure spending would be on public and private cloud by 2020.
Cloud demand remains vibrant despite softer capital spending. U.S. hyperscale CSPs continue to report exceptionally strong revenue growth. Amazon Web Services (AWS) reported 46% YoY growth (Figure 4) while Microsoft Azure posted a 76% YoY gain in 3Q 2018. Despite the recent slowdown in capex growth, we expect Amazon’s revenue growth to remain robust at 35% YoY in 2019, with a 40% CAGR through 2019 (Figure 5). According to Gartner Research, global public cloud revenue is projected to grow at a 14% 5-year CAGR with Infrastructure-as-a-Service growing the fastest (Figure 6), while revenue for the 5 largest CSPs is expected to grow at a CAGR of 29% (Figure 7).
Cloud-related services will drive spending in the cloud industry as enterprises embark on the cloud journey. According to IBM, 80% of enterprise workloads have yet to migrate to cloud despite high adoption rate of a multi-cloud strategy. Most of the enterprises are still in the transitioning phase to a hybrid cloud IT environment. This presents a great growth opportunity as they look for cloud service providers that provide end-to-end solutions to aid in the complex digital enablement. It is predicted that for every $1 spent on public cloud infrastructure (hardware), enterprises are projected to spend between $2-$5 on services such as cloud readiness surveys, cybersecurity, multi-cloud management and migration services.
RECOMMENDATION
There was a large spike in cloud capex, in particular 1Q18 (Figure 1). Since then market needed some time to digest the extra capacity. The market has reacted negatively to the deceleration in cloud capex. The First Trust Cloud Computing ETF (SKYY) has declined 8.2% from its peak in Sep 2018.
We believe that this presents a compelling buying opportunity. Companies’ continue to express confidence about data centre buildouts in 2019 and beyond. Historically, the digestion period will take 1-3 quarters (Figure 1), which implies that cloud spending may pick up again in 2H 2019. Companies confirmed the length of the digestion, which is consistent with the historical cloud cycle. STX estimates a 3-quarter digestion period while WDC expects cloud spending to normalise in 2H 2019.
Therefore, we are giving a BUY call for First Trust Cloud Computing ETF (SKYY) which tracks stocks in the cloud computing sector. As there is increasing market consolidation with hyperscale CSPs seeking to expand and upgrade their services via acquisitions, we prefer Google (AAPL), IBM (IBM) and Microsoft (MSFT). These 3 companies are likely to exert their market dominance with mature technologies and diversified cloud services.
Important Information
This report is prepared and/or distributed by Phillip Securities Research Pte Ltd ("Phillip Securities Research"), which is a holder of a financial adviser’s licence under the Financial Advisers Act, Chapter 110 in Singapore.
By receiving or reading this report, you agree to be bound by the terms and limitations set out below. Any failure to comply with these terms and limitations may constitute a violation of law. This report has been provided to you for personal use only and shall not be reproduced, distributed or published by you in whole or in part, for any purpose. If you have received this report by mistake, please delete or destroy it, and notify the sender immediately.
The information and any analysis, forecasts, projections, expectations and opinions (collectively, the “Research”) contained in this report has been obtained from public sources which Phillip Securities Research believes to be reliable. However, Phillip Securities Research does not make any representation or warranty, express or implied that such information or Research is accurate, complete or appropriate or should be relied upon as such. Any such information or Research contained in this report is subject to change, and Phillip Securities Research shall not have any responsibility to maintain or update the information or Research made available or to supply any corrections, updates or releases in connection therewith.
Any opinions, forecasts, assumptions, estimates, valuations and prices contained in this report are as of the date indicated and are subject to change at any time without prior notice. Past performance of any product referred to in this report is not indicative of future results.
This report does not constitute, and should not be used as a substitute for, tax, legal or investment advice. This report should not be relied upon exclusively or as authoritative, without further being subject to the recipient’s own independent verification and exercise of judgment. The fact that this report has been made available constitutes neither a recommendation to enter into a particular transaction, nor a representation that any product described in this report is suitable or appropriate for the recipient. Recipients should be aware that many of the products, which may be described in this report involve significant risks and may not be suitable for all investors, and that any decision to enter into transactions involving such products should not be made, unless all such risks are understood and an independent determination has been made that such transactions would be appropriate. Any discussion of the risks contained herein with respect to any product should not be considered to be a disclosure of all risks or a complete discussion of such risks.
Nothing in this report shall be construed to be an offer or solicitation for the purchase or sale of any product. Any decision to purchase any product mentioned in this report should take into account existing public information, including any registered prospectus in respect of such product.
Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may provide an array of financial services to a large number of corporations in Singapore and worldwide, including but not limited to commercial / investment banking activities (including sponsorship, financial advisory or underwriting activities), brokerage or securities trading activities. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have participated in or invested in transactions with the issuer(s) of the securities mentioned in this report, and may have performed services for or solicited business from such issuers. Additionally, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have provided advice or investment services to such companies and investments or related investments, as may be mentioned in this report.
Phillip Securities Research or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report may, from time to time maintain a long or short position in securities referred to herein, or in related futures or options, purchase or sell, make a market in, or engage in any other transaction involving such securities, and earn brokerage or other compensation in respect of the foregoing. Investments will be denominated in various currencies including US dollars and Euro and thus will be subject to any fluctuation in exchange rates between US dollars and Euro or foreign currencies and the currency of your own jurisdiction. Such fluctuations may have an adverse effect on the value, price or income return of the investment.
To the extent permitted by law, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may at any time engage in any of the above activities as set out above or otherwise hold an interest, whether material or not, in respect of companies and investments or related investments, which may be mentioned in this report. Accordingly, information may be available to Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, which is not reflected in this report, and Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may, to the extent permitted by law, have acted upon or used the information prior to or immediately following its publication. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited its officers, directors, employees or persons involved in the issuance of this report, may have issued other material that is inconsistent with, or reach different conclusions from, the contents of this report.
The information, tools and material presented herein are not directed, intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution, publication, availability or use would be contrary to the applicable law or regulation or which would subject Phillip Securities Research to any registration or licensing or other requirement, or penalty for contravention of such requirements within such jurisdiction.
This report is intended for general circulation only and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. The products mentioned in this report may not be suitable for all investors and a person receiving or reading this report should seek advice from a professional and financial adviser regarding the legal, business, financial, tax and other aspects including the suitability of such products, taking into account the specific investment objectives, financial situation or particular needs of that person, before making a commitment to invest in any of such products.
This report is not intended for distribution, publication to or use by any person in any jurisdiction outside of Singapore or any other jurisdiction as Phillip Securities Research may determine in its absolute discretion.
IMPORTANT DISCLOSURES FOR INCLUDED RESEARCH ANALYSES OR REPORTS OF FOREIGN RESEARCH HOUSE
Where the report contains research analyses or reports from a foreign research house, please note:
Edmund covers the US Market Strategy. He was previously a risk transformation consultant in the Big Four.
He graduated with a Bachelor of Accountancy (Honours) with a major in Finance from the National University of Singapore.