Looking at the cloud from the street
To provide more commercial context for the legal and regulatory issues associated with cloud computing, we spoke to leading investment bankers to get their perspectives on cloud computing. Three themes emerged from our conversations: (i) cloud computing is not a one dimensional, uniform business model; (ii) the emergence and growth of cloud computing have been, and will continue to be, strongly driven by increased efficiency and cost savings; and (iii) cloud computing is expected to continue to spawn a wide variety of financing and M&A transactions.
The cloud is not one dimensional
Every conversation about the commercial implications and dimensions of cloud computing started with an acknowledgement that the term "cloud computing" refers to a range of different business models and commercial activities. McKinsey defines "cloud computing" as "A computing paradigm in which highly scalable computing resources, often configured as a distributed system, are provided as a service through a network."1 The Storage Network Industry Association describes cloud computing as "a new business model wrapped around existing technologies, such as server virtualization, to make the use of information technology resources more efficient."2 These definitions help to define the technical and structural attributes of cloud computing, but not the different business models that have already emerged.
IaaS, SaaS, and PaaS
At the bottom tier of cloud services are business models that are referred to as infrastructure as a service, or "IaaS" – customers obtain processing, storage, network capacity and other computing resources from a cloud (i.e., Internet-accessed) infrastructure. Examples of IaaS businesses include data storage offered by Rackspace Hosting and Amazon Web Services. These businesses provide remote data storage, generally on shared servers remotely located from the clients, and enable access to, and interaction with, the stored data over the Internet. Another model is software as a service, or "SaaS" – customers use applications running in a cloud infrastructure. These include G-Mail, Cytrix, LinkdIn and other hosted applications. A third type
of cloud service offering is the platform as a service, or "PaaS" – customers develop applications in a cloud infrastructure. Examples of PaaS business models include SalesForce's Force.com and Microsoft's Azure. As these examples show, cloud computing spans a wide variety of potential users from large enterprise customers, to small and mid-cap businesses, as well as consumers themselves. Cloud computing in all forms is growing fast. A recent McKinsey study estimates that SaaS is growing at a 17% annual rate3, while "cloud revenue" at Rackspace was reported to have grown by 83.4% year over year in the 4th quarter of 20104
"Form CAPEX to OPEX"
The core business drivers of the evolution of cloud computing are efficiency and cost savings – the providers of cloud based IT services and facilities enable their customers to gain access to highly scalable, shared resources, which are offered on an on-demand, a la carte, basis. In this manner, both operating expenses and capital costs can be shared, thereby reducing the costs to each user as compared to building and maintaining their own data centers and functionality. Notwithstanding the obvious economic benefits of outsourcing certain IT services to the cloud, experts believe that 80% to 90% of data center capacity is still being maintained "in house" at facilities that are largely underutilized, underpowered and under-cooled. UBS Wealth
Management Research's George Lambertson noted, "companies that are willing to share can achieve high cost savings." Stuart Goldstein of Moelis believes that the recession helped accelerate the move to cloud computing, because "people had to do more with less." By adopting cloud based services, businesses were able to shift from "cap ex to op ex" during a time when access to capital was increasingly difficult. In the business to business environment, the efficiencies and cost savings of cloud
computing are now being extended down from large enterprises to middle market and smaller companies5.
Investment bankers identify security risks as a potential drag on the rate of adoption of cloud based services. Individuals are increasingly focused on protecting their personal data, such as financial and health information, while businesses continue to be concerned with protecting competitively sensitive data as well as the personal data of their customers. On the other hand, there was a general recognition that younger people, who have grown up in a world that emphasizes more collaborative behavior and greater sharing of information, are less resistant to the idea of moving critical data and functionality into an ecosystem of shared services and facilities. As generational shifts take place within companies, and in the general market place, the adoption rate of cloud based services is expected to increase.
How could security not be a concern in the wake of the recent cyber attack on Sony's Play Station Network ("PSN") which exposed an estimated 100 million users to the loss of personal information and credit card data?6 While the PSN fiasco was described by our investment banking contacts as "frightening" and the kind of "train wreck" that causes everyone to take a step back, the consensus was that these kinds of stumbles will not slow growth of the cloud. Rather than causing businesses to abandon cloud based business models, large security breaches or performance failures, are expected to cause industry participants to redouble their focus on strengthening security and capacity. A recent McKinsey report stated, "With security breaches on the rise, addressing data security through technological and policy tools will become essential."7 While it may be the case that, in the short term, security concerns are motivating companies to hold onto their "mission critical" applications and data, the investment bankers we spoke to believe that the need for new and better security measures in the cloud will be solved by further investment and innovation.
IP protection is top-of-mind
In addition to data security another risk that is top of mind, especially for stakeholders in the TMT Sector, is IP protection. Deutsche Bank's Brian Mulligan shared the perspective that in order for cloud based services to become one of the primary distribution channels for first run television and movie content, the critical factors that will need to be addressed are security, IP protection, cultural biases (towards traditional consumptions platforms) and windowing. Issues surrounding IP protection are expected to become more prevalent with the growth of cloud based content delivery services such as Apple's iCloud music service, which will enable users to store music libraries on Apple's servers that can be accessed over the Internet from a variety of devices8.
Building businesses on the back of infrastructure providers
All of the investment bankers that we spoke to believe that we are still in the early stages of the cloud computing business evolution, and they anticipate a growth in both internal investment and M&A activity. Guggenheim's Andrew Decker anticipates that there will continue to be significant demand for capital to build data centers and provide connectivity. At the other end of the spectrum, start up businesses will emerge to provide unique services or incremental technology improvements that leverage the existing cloud infrastructure, as well as businesses that can be built around the exploitation of by-products of the cloud – such as the data about usage (valuable usage data is generated as a "by-product" of conducting business over a network). As Stu Goldstein put it, there are great opportunities to "build businesses on the back of the infrastructure providers," and since the infrastructure already exists the costs of entry into the cloud computing space have come down. Rackspace has been aggressively promoting the potential of the OpenStack cloud platform to spawn new businesses using open API's and software9. There have already been some significant (multi-billion dollar) deals in the cloud computing sector, including Verizon's acquisition of Terramark and Microsoft's purchase of Skype. Andrew Decker expects to see more deals where, in addition to large software companies, network operators with large customer bases (such as telcos and cable companies) will move to acquire smaller cloud oriented service providers to be able to address the growing demands of their customers for cloud based services. Time Warner Cable's recent acquisition of Navisite (a managed and cloud hosting company), is another example of this trend. The rapid growth and evolution of cloud computing capabilities are driving vendors to compete through technological innovation and the development of new business models to meet the needs of different customers.10 Stu Goldstein also believes that growing customer demand and sophistication will force traditional players to acquire the smaller companies that emerge as leading innovators (e.g., in security or applications). With all of this innovation, growth and consolidation, will come capital raising, joint ventures, strategic alliances and M&A transactions.