CLOUD COVER

As tech giants like Microsoft and Google increasingly permeate our lives and remote working becomes mainstream, cloud computing has emerged as the biggest theme of the digital revolution. In this paper we examine how the big four infrastructure-as-a-service players are effectively the modern day railroads with a new wave of software providers that are changing the way we live and work and the resultant investment opportunities.

Key Points

• Cloud computing’s share of global IT spend is rapidly expanding
• The cloud ecosystem comprises the software manufacturers and the infrastructure hosts on whom they depend
• Infrastructure is dominated by an established big four–but the software sector represents exciting territory for finding tomorrow’s winners
• Cloud computing expenditure is still in its infancy and has a very long growth runway ahead

Remoteness has become a familiar concept in the Covid-19 world with millions of people enduring lockdown isolation, while the corporate transformation to home working gathers pace and employees scattered across the globe are brought together in virtual teams.

The enabler of this remote revolution is ‘the cloud’, the excitingly futuristic term for what is simply the centralised offsite provision of computing resources – be it data storage, servers, apps or networking tools – via on-demand access over the internet. ‘Digital transformation’ has become a favoured mantra within companies worldwide almost to the point of cliché, while what it usually means is simply the migration of computing services to the cloud. Even to people using computers only for personal reasons, accessing remote services for data storage, apps and security is a far simpler solution than doing it all yourself on your desktop.

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The cloud is taking an increasingly bigger share of worldwide IT spend – and at the same time, the lines between IT subsectors such as software, devices and data are becoming blurred within the one-stop-shop cloud ecosystem. Digital Enterprise, in which cloud computing is our primary concern, has been one of Munro Partners’ Areas of Interest (AoI) since 2016. Since then, the sector has grown exponentially, as the chart below shows. Today, Digital Enterprise is one of the biggest and most exciting AoIs at Munro.

Cloud computing is growing aggressively across two sub-sectors. The well-established infrastructure and hosting providers (known as Infrastructure as a Service, or IaaS) are building data centre farms around the world to enable computer services to be hosted in the cloud.

Then the application layer of cloud computing (Software as a Service, or SaaS) is seeing a newer generation of providers building amazing pieces of software on these IaaS platforms. Many of these SaaS public cloud vendors actually outsource most of their core computing needs back to the big IaaS providers, who offer pure cloud storage and computing at highly discounted rates in what has become a scale game of cost and security. This provides huge benefits for software companies and corporates worldwide, enabling them to run any application or operating system and scale up or down depending on fluctuations in demand.

THE POWER OF THE BIG FOUR

At Munro Partners, we liken today’s cloud-based virtual computing platforms to the railroads that enabled the growth of the industrial revolution in Europe and the US – although free of geographic constraints and growing much faster than any railway could ever be built.

The IaaS sector is dominated by Google, Microsoft, Amazon and Alibaba to the extent that virtually all the companies we meet around the world are migrating to the cloud in some form via one of these vendors. They are the big winners, providing scalable commoditised computing power via their networks of data centres and servers and accounting for around 94%of the global IaaS market.

The sheer size of these four – Microsoft’s market capitalisation is in the trillions – and scalability they offer allow costs to continue to fall with no downside on performance or reliability, thus further accelerating demand and transition to the cloud. At the same time, this makes it extremely difficult for new competitors to threaten their market dominance.

LAND AND EXPAND

SaaS is the application layer of cloud computing, where users can access services anywhere, anytime over the internet. To extend our railroad analogy, we look on these companies as the locomotives and rolling stock – delivering their products (computer software, rather than oil and steel) to consumers and businesses alike.

Most people now understand cloud computing because they have subscriptions to tools like Zoom. Many companies are now using IaaS platforms to build software that many of us use in our working lives, such as Zero, Salesforce, Workday – and Microsoft, which sits on its own stack to offer collaboration tools such as Teams within its all-encompassing Microsoft 365 subscription service.

The success and future growth prospects of these software providers is based around a concept called ‘land and expand’, whereby a company initially subscribes to a software service for perhaps one element of its business operations. Then over time the provider introduces more and more irresistible value-add services, and thus becomes immovably embedded across all an organisation’s operations.

THE NEXT MICROSOFT?

Microsoft is now so huge and so deeply embedded in the way the modern world operates that it can be described as ‘the software company for the planet’, with all of us likely to be dependent on Microsoft for many years to come. But this isn’t to say that a new generation won’t emerge, and we’re already seeing many contenders such as Salesforce, Adobe, Workday and others. However, to provide an illustrative example of these potential next generational winners, here are workplace software providers Atlassian and ServiceNow.  

THE FUTURE OF WORK IS ATLASSIAN

Atlassian is a Sydney-based company that has grown since its foundation in 2002 to become the leading global provider of collaboration software. Its products help big remote teams execute projects by combining everything in one place for ease of storage, version control and streamlined communications.

Atlassian has all the qualities we think a company needs to execute on the digital enterprise growth runway. In particular, we see the following as key reasons for its excellent prospects.

MINIMAL MARKETING

Rather than employ big sales teams, Atlassian relies on having a great product and word of mouth –resulting in what is effectively viral adoption of its software. This gives it the lowest sales to marketing spend among its peers yet also the highest research and development spend. This bold strategy perhaps explains why some of Atlassian’s products – such as Jira, their project workflow software – are better known than the name of the parent company itself.

 MORE CUSTOMERS, MORE LOVE

Atlassian has hundreds of thousands of customers globally, with the average one paying less than $10,000 for its product –compared with say Workday where the equivalent figure is nearly $500,000.For Atlassian, this translates into an incredibly long runway of growth and the potential to scale up in price as its products become ever more deeply permeated into the operating processes of its client companies.

Atlassian has just 15 million users today from the estimated 1.1billion knowledge workers in the world – all of whom, one way or another, could end up using Atlassian products.

THINKING AHEAD

The third and most important reason we like Atlassian is the attitude of its founders, Mike Cannon-Brookes and Scott Farquhar. They launched the company in 2002 with little venture capital, relying instead on developing a great product with viral uptake potential. Still targeting ‘big hairy audacious goals’, they focus even today only on what is best for the company’s long-term interests. Our qualitative investment process  gives it a quality score of 100%,a rating shared by a mere handful of companies in our entire investment universe.

Atlassian trades on very high multiples and is probably considered a highly expensive company. But it’s a classic example of how the market is underestimating the size of the opportunity and how long the digital enterprise growth runway will be. It maybe a bumpy road at times, but we’re confident that Atlassian is well placed to execute on this huge opportunity.

SERVICENOW:TAKING CARE OF BUSINESS

A classic land and expand success story, American software provider ServiceNow started with one product in 2016 but has grown to become a broad multi-product platform for workflows within a business. It is now deeply embedded within many organisations, benefitting from the high renewal rates for customers with multiple products, as the chart below shows.

We see a huge runway of growth in front of ServiceNow. While revenues are currently around $5 billion from a global revenue potential of $25 billion, the company has a revenue target of $15 billion by2026 – by which time revenue potential is forecast to rise to $216 billion. But even then, it will still have penetrated only about 7% of its target market.

 As with Atlassian, ServiceNow looks expensive by the usual metrics – but it has been worth paying a high multiple for ServiceNow over the last three years. We see its growth rates of30% per annum being very sustainable and anticipate strong compound returns from this stock for many years to come.

THE FUTURE

More and more people now understand clouds computing via Zoom subscriptions and familiarity with Microsoft Teams, as remote ways of working have become mainstream and even our children are moved to online learning. Coupled with innovation in other fields like remote medical consulting, the shift to the cloud will only accelerate from here.

Yet cloud computing expenditure as a percentage of total IT expenditure is still in its infancy at only around 5%-6%,so we see a very long runway of growth ahead.

Munro Partners has owned Microsoft, Google, and Amazon since our establishment  in 2016 and owned them for many years before that at our previous firm, providing our clients with strong absolute and relative returns as the cloud computing revolution has played out.

 Along with Atlassian and ServiceNow we also see many other exciting opportunities emerging as new players gain footholds in organisations and follow the land and expand pathway to success, helping run the world’s businesses for the next 10 or 20 years. From our point of view this makes for some wonderful investment opportunities over a very long time horizon.

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