Cloud Computing – Only a near-term indigestion January 31, 2019 887


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.


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.

  1. Apple announced that it plans to invest $10B in US data centre construction over the next 5
  2. Google is currently at different stages of development for 20 data centre sites globally.
  3. Facebook’s 3Q 2018 earnings call suggested a data centre build strategy across Asia, North America and Europe.
  4. China Cloud providers are also increasing data centre buildouts outside China.
  • Tencent opened its first data centre in India this year, while building its second in Hong Kong. It has plans to launch data centres in Thailand, Russia and Japan.
  • Baidu is building up its own GPU-centric data centres by leveraging on partnerships with Inspur and STX.

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.


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.

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About the author

Profile photo of Edmund Xue

Edmund Xue
Research Analyst
Phillip Securities Research Pte Ltd

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.

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