August 17, 2020

UW Finance Association Computing Industry Primer Market Research Research and Education

Cloud Computing Industry Primer

All amounts in $US unless otherwise stated. Author(s): What is ? Rohit Dabke, Kevin Hsieh and Ethan McTavish According to the National Institution of Standards and Research Analysts Technology (NIST), Cloud Computing is defined as a model for Editor(s): enabling network access to a shared pool of configurable John Derraugh and Brent Huang computing resources that can be rapidly provisioned. In more Co-VPs of Research and Education layman terms, Cloud Computing is the delivery of different computing resources on demand via the . These computing resources include network, servers, storage, applications, and other services which users can ‘rent’ from the service provider at a cost, without having to worry about maintaining the infrastructure. As long as an electronic device has access to the web, it has access to the service provided. In the long run, people and businesses can save on cost and increase productivity, efficiency, and security.

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Exhibit 1: See below the advantages and features of cloud computing.

In general, cloud computing can be broken down into three major categories of service models: Infrastructure (IaaS), (PaaS), and as a Service (SaaS). Infrastructure as a Service (IaaS) IaaS involves the cloud service provider supplying on-demand infrastructure components such as networking, servers, and storage. The customer will be responsible for establishing its own platform and applications but can rely on the provider to maintain the background infrastructure.

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Major IaaS providers include (), (Amazon Web Service), IBM (IBM Cloud), , and Alphabet ( Cloud). Platform as a Service (PaaS) PaaS builds upon IaaS and includes the delivery of an established platform (i.e. the underlying language, library, tools, etc.) to the customer. The customer can utilize these tools to develop, manage, and host its own applications.

Most IaaS providers listed in the above section also provide PaaS. (SaaS) SaaS is the on-demand delivery of software applications by the service provider to the customer. Instead of installing the software locally, customers can simply access the software application via the Internet. Examples of such software include services such as , Office365, CRM and ERP solutions, etc.

Major SaaS companies include: , SAP, Oracle, in addition to previous examples mentioned. Industry Summary

Cloud Computing is an industry that has come to relevancy over the past decade as businesses and individuals alike began the transition from investing in proprietary hardware such as servers and storage, to simply paying a service provider who will store and maintain information remotely. Even though the industry has already experienced tremendous growth, it is still expected to continue this upwards trend. An estimated $229 billion dollar industry as of 2019, the subsector is expected to double this number to around $500 billion in 2023, with a compound annual growth rate (CAGR) of 22.3% according to eSP (European Solution Providers).

Of the three broad types of cloud computing, SaaS is the largest category, accounting for 57.1% of the total industry value as of 2019. IaaS follows as the second largest category of spending, and it is also anticipated to experience the highest growth, with an estimated five-year CAGR of 32.0%. PaaS is also estimated to experience a similar level of growth, with an estimated five-year CAGR of 29.9%. In terms of geography, the is the predominant market for cloud computing, accounting for 55.5% of the global cloud industry. 5 Forces Analysis Rivalry

Although there is great competition amongst competitors, the industry has experienced rapid growth over the past few years, and there exists many small players in different niches that are able to compete against larger players, reducing the degree of rivalry to a moderate level.

Buyer power

Buyers of cloud services range from individuals and small companies to large global conglomerates or even government bodies, and thus the level of buyer power will vary. Of course, larger buyers tend to have more financial leverage and the ability to influence prices, while smaller buyers may not have that privilege. The industry often employs a pay-as-you-go format that charges based on usage, wherein

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customers can terminate their contract without too much difficulty. In general, customers have a moderate level of buyer power.

Supplier power

As with the case of modern technology companies, a major “supplier” of cloud computing companies is skilled workers who possess necessary technological expertise to help a company develop its products. There is a high demand for these skilled workers among the industry, and top cloud developers usually command lucrative compensation.

Other sources of input for cloud computing companies include hardware and raw material. In terms of raw material, IaaS providers require specialized material such as silicon, which is a highly specialized industry in its own right. Thus, major silicon suppliers enjoy a great degree of supplier power. Hardware/hardware component suppliers similarly have high supplier power as these respective industries have limited players. The overall supplier power of the cloud computing industry is strong.

New Entrants

There is definitely potential for small scale companies to enter the cloud computing industry and survive if they are able to find particular niches and provide specific services, for instance, healthcare or finance related solutions. However, financial resources are required to scale the business to a higher level, which gives larger companies greater advantage. In addition, regulation is dependent on the type of service provided. Financial service providers are subject to higher regulation than the typical cloud service provider. In general, the potential of new entrants in the industry is average.

Substitutes

Cloud computing is technically speaking a substitute for traditional IT software/systems that are hosted or installed internally within a company, so companies do have the option to revert to or stick with existing systems depending on a variety of reasons. However, the cloud computing industry experienced massive growth over the past decade precisely because cloud services offer key advantages over traditional IT systems. For one, employing cloud services can reduce capital expenditure by a considerable amount compared to maintaining and upgrading a company’s own hardware. Additionally, cloud software services are more accessible and flexible in the modern day compared to locally installed software. The only concern with choosing cloud computing over traditional infrastructure is the issue of security. Wherein a company will choose to store sensitive data and information in internal , rather than risk exposing it via a potentially insecure network. Overall, the threat of substitutes is low. Main Players

There are numerous companies in the cloud computing space including small-cap companies to large, some specializing in specific sectors such as healthcare or the restaurant industry, etc. Nevertheless, the industry is largely dominated by tech giants including:

• Alibaba (Alibaba Cloud) • Alphabet (Google Cloud) • Amazon (Amazon Web Service) • IBM (IBM Cloud) • Microsoft (Microsoft Azure)

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• Oracle () • Salesforce

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Exhibit 2: See below the market share of largest cloud computing segment SaaS, and the smaller two, IaaS and PaaS in 2019. Source: Synergy Research Group

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Alibaba (NYSE:BABA)

Alibaba Group Holding Limited provides online and mobile commerce business internationally. The company operates through four segments: Core Commerce, Cloud Computing, Digital Media and Entertainment, and Innovation Initiatives and Others. Its Cloud Computing segment, $702,227M predominately Alibaba Cloud was founded in 2009 and accounts for Market Capitalization 6.6% of its LTM total revenue. Alibaba is the largest cloud computing (July 13, 2020) company in China which has grown its market share through a joint $72,853M venture with SoftBank and partnered with SK Holdings in 2016. Its LTM Total Revenue Cloud Computing segment provides SaaS, IaaS, and PaaS. This includes (March 31, 2020) storage, analytics, and machine learning platforms. The company was founded in 1999 and is based in , China. Alphabet (NASDAQ:GOOG) Alphabet Inc. provides online advertising services, digital content, and cloud services internationally, through Google. Among numerous products including: Android, Chrome, and YouTube, its cloud $1,060,000M computing product, Google Cloud was launched in 2008 and accounts Market Capitalization (July 13, 2020) for 5.5% of its LTM total revenue. The company acquired several competitors to grow its cloud business including bebop, , $166,677M and all between 2015-2019. Through Google Cloud it LTM Total Revenue (March 31, 2020) provides IaaS, and PaaS, which includes , data analytics, and machine learning. The company was founded in 1998 and is headquartered in Mountain View, California. Amazon (NASDAQ:AMZN) Amazon.com Inc. engages in the retail sale of consumer products and subscriptions internationally. It sells mainly through its online stores merchandise purchased for resale from third-party sellers. In addition, $1,617,000M through its cloud computing segment (AWS), Market Capitalization which officially re-launched in 2006 owns a dominant 34% of IaaS and (July 13, 2020) PaaS, which focuses on storage, and functions. AWS accounts $296,274M for 12.5% of Amazon’s LTM total revenue and is a major market player LTM Total Revenue (March 31, 2020) with help from acquiring Graphiq and Sqrrl in 2017 and 2018, respectively. The company was founded in 1994 and is headquartered in Seattle, Washington.

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IBM (NYSE:IBM) International Business Machines Corporation (IBM) is a worldwide integrated solutions and services company. Through its Cloud & Cognitive Software segment which includes IBM Cloud (released in $107,240M 2011) focuses on software analytics and integration software (IaaS, Market Capitalization PaaS) in the banking, airline, and retail industries. With the help of a $34 (July 13, 2020) Billion deal with , IBM has established itself as a key player in $76,536M the cloud computing industry. With its Cloud & Cognitive Software LTM Total Revenue (March 31, 2020) segment accounting for 27.2% of the company’s LTM total revenue. The company was founded in 1911 and is based in Armonk, New York. Microsoft (NASDAQ:MSFT) Microsoft Corporation develops, licenses, and supports software, services, devices, and solutions worldwide. Some of its products include: Office, Microsoft Teams, Skype for Business, Visual Studio, and $1,614,000M Xbox. Its Intelligent Cloud segment licenses SQL, Window Servers, and Market Capitalization (July 13, 2020) Visual Studio. In addition, the acquisition of GitHub in 2018 provides code hosting services. Another large part of its Cloud segment is Azure, $138,699M LTM Total Revenue released in 2010 which is a cloud platform. This segment of the (March 31, 2020) company provides 31% of Microsoft’s LTM total revenue. Microsoft was founded in 1975 and is headquartered in Redmond, Washington. Oracle (NYSE:ORCL) provides products and services that address enterprise information technology environments worldwide. Its SaaS $176,587M segment offers a suite of cloud software applications including Market Capitalization enterprise resource planning (ERP). Additionally, the company offers (July 13, 2020) operating systems including Oracle Linux and Oracle Solaris. In total $39,068M 82.4% of Oracle’s LTM total revenue comes from its company’s cloud LTM Total Revenue and license business. The company was founded in 1977 and is based in (May 31, 2020) Redwood City, California. Salesforce (NYSE:CRM) Salesforce.com, Inc develops enterprise cloud computing solutions with a focus on customer relationship management worldwide and is solely $173,884M in the cloud computing space. The company offers Sales Cloud to its Market Capitalization (July 13, 2020) customers which stores data, forecasts opportunities and helps them gain insights through analytics and relationship intelligence. In general, $18,226M LTM Total Revenue Salesforce focuses predominantly on SaaS and PaaS. The company was (April 30, 2020) founded in 1999 and is headquartered in San Francisco, California.

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Pure Cloud Computing Comparative Analysis As many of the above companies have a wide variety of revenue sources besides cloud computing. It does not accurately represent the companies within the industry. Some of the pure cloud computing companies are listed in Exhibit 3.

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Exhibit 3: See below a comparative summary of pure cloud computing companies in the industry.

Pure Cloud Computing Comparative Analysis All figures in USD $Millions June-27-2020 Equity Enterprise Sales EBITDA Earnings LTM Debt/ TEV/Revenue TEV/EBITDA Company Value Value LTM 2021E LTM 2021E LTM 2021E EBITDA LTM 2021E LTM 2021E AppFolio (NASDAQ:APPF) 5,406 5,475 271 385 18 62 35 40 7.5x 20.2x 14.2x 305.9x 87.8x Citrix Systems (NASDAQ:CTXS) 17,625 19,056 3,152 3,276 774 1,097 753 762 2.6x 6.0x 5.8x 24.6x 17.4x Salesforce.com (NYSE:CRM) 165,036 161,446 18,226 20,077 2,051 5,977 -167 2,743 3.0x 8.9x 8.0x 78.7x 27.0x ServiceNow (NYSE:NOW) 76,276 75,620 3,718 5,439 380 1,635 677 1,077 3.2x 20.3x 13.9x 198.9x 46.3x (NASDAQ:SPLK) 31,265 31,666 2,368 2,429 -332 19 -487 -56 nm 13.4x 13.0x nm 1693.4x Twilio (NYSE:TWLO) 30,973 29,778 1,266 1,905 -268 146 -365 30 nm 23.5x 15.6x nm 204.2x Veeva Systems (NYSE:VEEV) 35,274 33,946 1,196 1,390 328 530 314 410 0.2x 28.4x 24.4x 103.6x 64.1x Wix.com (NASQAD:WIX) 12,976 12,697 803 1,187 -73 216 -95 102 nm 15.8x 10.7x nm 58.9x Workday (NASDAQ:WDAY) 44,090 43,591 3,821 4,195 -158 971 -523 572 nm 11.4x 10.4x nm 44.9x Min 5,406 5,475 271 385 -332 19 -523 -56 0.2x 6.0x 5.8x 24.6x 17.4x Median 31,265 31,666 2,368 2,429 18 530 -95 410 3.0x 15.8x 13.0x 103.6x 58.9x Mean* 46,547 45,919 3,869 4,476 302 1,183 16 631 3.3x 16.4x 12.9x 142.3x 68.8x Max 165,036 161,446 18,226 20,077 2,051 5,977 753 2,743 7.5x 28.4x 24.4x 305.9x 1693.4x *mean TEV/EBITDA excludes Splunk Key Valuation Metrics

Aside from traditional valuation metrics such as P/E Ratio, DCF valuation, trading multiples, companies in the cloud computing industry can also be valued by some industry specific metrics. Committed monthly recurring revenue (CMRR) Committed monthly recurring revenue is a metric that looks at adding expansions (new subscription, upgrades) to existing recurring revenue, and subtracting known contractions and churn away. This metric gives forward looking insight to the growth of the customer base. The commonly known formula for CMRR is

CMRR = MRR + New Subscriptions - Churn Customer acquisition cost payback period (CAC) Customer acquisition cost payback period is the amount of time it takes for a customer to pay the amount it costs for the company to acquire the customer. The formula for CAC payback period is

CAC payback period = CAC / (Average revenue per account * Gross Margin)

Typically, a good CAC payback period should be less than 12 months Customer lifetime value (CLTV) Customer Lifetime Value is the amount of revenue expected from a single customer over the customer’s total subscription duration. The formula for CLTV is

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CLTV = Average revenue per account * Gross Margin * Lifetime

For a company to be profitable, the CLTV should be greater than the CAC. Churn Churn refers to the rate at which customers cancel a subscription with the company. There are multiple metrics that involve looking at churn rate differently. For example, if one is concerned with the number of customers lost, customer churn rate measures the percentage of customers lost over a certain period. Churn can also be combined with other numbers to show different values. Industry Trends

M&A Activity Within the technology space, mergers and acquisitions is an ever-growing trend. In recent years the M&A landscape has been mostly characterized by large tech giants acquiring emerging start-ups. This helps companies build out their service platforms and accelerates the overall trend of companies moving to public cloud. However, over the last year two big acquisitions have been announced within the space.

International Business Machine (NYSE: IBM) Acquisition of Red Hat

On July 9, 2019 International Business Machine or more commonly known as IBM completed the acquisition of Red Hat worth $34 Billion. Red Hat provides services for its version of the open-source (free from licensing costs) Linux software operating systems, middleware, storage, virtualization, and management tools. IBM is a world leader that is active in almost every aspect of an enterprise’s IT needs. The objective behind the acquisition was for IBM to gain a significantly larger position of market share within the hybrid cloud computing industry. Valuation metrics for this deal include: TEV/Revenue of 9.76x and TEV/EBITDA of 52.51x.

Kronos Incorporated Acquisition of Ultimate Software Group

On April 1, 2020, Kronos Incorporated completed the acquisition of The Ultimate Software Group for $22 Billion. The transaction is an all-stock merger, initiated by Hellman & Friedman, the majority owner of both, Kronos and Ultimate Software. Kronos Incorporated is a multinational workforce management and human capital management cloud provider. The deal is a horizontal merger since the Ultimate Software Group is as well a provider of cloud-based human capital management. The objective of the transaction was for Kronos to consolidate its human capital management cloud services and gain a larger position within the space.

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Exhibit 4: See below other notable deals in cloud computing industry.

Cloud Computing Precedent Transactions All figures in USD $Billions Deal Deal Metrics Acquirer Target Value TEV/Revenue TEV/EBITDA Year Cornerstone OnDemand (NASDAQ: CSOD) Saba Software 1.3 2020 Salesforce (NYSE: CRM) Vlocity 1.3 13.3x 2020 Alphabet (NASDAQ: GOOGL) Looker 2.4 15.0x 2019 Dassault Systemes (PAR: DSY) Medidata Solutions 5.6 6.7x 30.0x 2019 Advance Publications Turnitin 1.8 11.7x 2019 Blackberry (TSE: BB) Cylance 1.4 2019 Microsoft (NASDAQ: MSFT) GitHub 7.5 2018 Atos (EPA: ATO) Syntel (NASDAQ: SYNT) 3.6 3.7x 13.4x 2018 State Street (NYSE: STT) Charles River Systems 2.6 2018 Salesforce (NYSE: CRM) MuleSoft (NYSE: MULE) 6.4 21.7x 2018 Growth Shift to Online Services

The increasing provision of services online will also lead to an increase in industry revenue, as companies rely on industry operators to handle the IT infrastructure and move platforms online. A report by IBISWorld shows that by 2025, the percentage of services conducted online will increase at an annualized rate of 10.0%, continuing a process that accelerated during the current period. As businesses are able to avoid the steep upfront costs of purchasing hardware and software previously required to operate online. Instead, by purchasing computing resources in smaller and smoother increments businesses can expand and shrink to meet changes in demand. In addition, in light of unexpected supply disruptions that can significantly increase the cost of hard drives, businesses that previously planned on handling their IT infrastructure needs internally may decide to outsource to industry operators.

Outsourcing Cloud Services

Over the coming decade, companies outside of this industry will likely focus investment on products designed to improve and streamline operations by adopting software that saves time and improves efficiency. Companies may find cloud resources difficult to maintain in-house or lack the necessary technical expertise. Hence, outsourcing is a common solution. In addition, outsourcing to industry operators enables companies to take advantage of the lowered costs offered by specialized operators in a time of rapid technological transformation, without compromising service. For small- and medium-sized businesses with limited IT budgets, outsourcing cloud service needs to industry operators eliminates the costly investments in cloud services or training employees. COVID-19 Impact: Short Term and Long Term Outlook

The pandemic is expected to weigh on demand significantly, as social distancing requirements and stay- at-home orders fuel a significant reduction in overall consumption. With a large number of businesses unable to turn a profit, investments in new technology are expected to slow down. As a result, demand for industry services will decline in the immediate future.

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However, moving forward, the impact of COVID-19 may accelerate a shift toward online services that has been well underway before the start of the pandemic. Companies may choose to have their employees work remotely, and many individuals may choose to forgo in-person commerce, such as brick-in-mortar clothing stores, for e-commerce alternatives. As a result, the industry may experience an uptick in demand in the long-term, even as the short-term impact on demand remains negative.

Exhibit 5: See below a map of COVID-19 cases per country as of June 28th, 2020.

As of June 28th, 2020 Headwinds Regulatory Issues: Since some of the major technological companies offer cloud services, their dominant position in the market has given rise to concerns about data protection, consumer rights and anti- competitive behavior. Further, issues such as data deletion, reduced visibility and control, loss of credentials have often been reported over the last couple of years.

Market Adoption: Although the industry continues to grow some large potential clients may resist change and continue to make use of fragmented services (physical servers in offices) for storage of data. Furthermore, since a large number of laws such as the Sarbanes-Oxley Act and the Federal Information Security Management Act govern data storage regulations, a thorough understanding of these is key and thus has resulted in a few companies not switching over to a cloud based system. Tailwinds Shift from an office-centric culture: COVID-19 has had a drastic impact on economies around the world, forcing companies to adapt to the changing circumstances and facilitate ‘Work-from-home’ opportunities. While the pandemic has had a large-scale impact on ‘traditional office life’, cloud providers have had the opportunity to provide some relief and flexibility to companies across the globe.

Increased M&A Activity: With almost every major player including Amazon, Microsoft, Alibaba, IBM now holding a dominant position within the industry, M&A activity is expected to grow at a rate of 18% per year as per a report by Deloitte Financial Advisory. The increased M&A activity is the consequence of players within the industry trying to gain a larger portion of the market share which will result in significant investments within the industry. The year 2019, was a massive year in M&A activity for the industry with total deal value crossing $270 Billion spread over almost 2,300 public and private transactions.

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