A Future Cloud King Is on Sale

Microsoft's cloud offerings don't get enough respect for how fast they are growing and shares are undervalued.

Jan 31, 2014 at 4:00PM

Microsoft (NASDAQ:MSFT) is much more than Windows 8 and Xbox. No matter how much attention the consumer segment gets in the press, the fact remains that Microsoft is an enterprise company-- and a very dominant one at that. Aggressively expanding its cloud services, it's also integrating its traditional, core businesses with Azure, which will facilitate a strong, cloud-based future for itself going forward.

A cloud-based CEO
With Ballmer on the outs,Satya Nadella will likely be his replacement. Nadella is more than just a Microsoft insider of more than two decades, he's also responsible for running its server and tools division since 2011. According to Kushagra Vaid, the company's general manager for server engineering, Microsoft manages an installed base of more than a million servers, delivering over 200 services to more than a billion customers. These customers come from over 90 markets. The company is also attempting to standardize and cheapen costs related to hardware, by contributing designs of its cloud servers to Facebook's Open Compute Project.

Going forward, it looks like Microsoft will be competing with Amazon (NASDAQ:AMZN) with a cloud-based operating system. This next generation back-end platform will be spread across public, private, and service provider clouds and power everything from Office 365 to Bing to Skype to Xbox Live. This is where Microsoft's "stickiness" is very valuable, as its cloud glues together various components and pieces of its offerings, integrating them into an ecosystem that's very hard to duplicate. If all goes to plan, it will be a dominant, diversified enterprise leader for a very long time. Therefore, Nadella seems like the perfect person to maneuver Microsoft into its future.

Competition abounds
That said, cloud-related competition will be cutthroat. Microsoft's Azure is still second behind Amazon Web Services, or AWS. Amazon is notorious for being the "cheapest" with its products and offerings, and AWS is no exception. Microsoft recently announced that it would cut the cost of Azure's storage costs to match Amazon's, in fact. This is a risk for Microsoft going forward, as a price war seems more like an edge for Amazon, who is currently the largest global provider of public cloud services.

For Microsoft's "cut prices when Amazon does" strategy to work, it must provide superior services. This is where its old moats come in, with Office, Skype, and other enterprise-standard offerings. If the enterprise likes Microsoft's enterprise-integrated cloud offerings, matching Amazon's price will help them gain market share for the long run. Once an enterprise buys into this ecosystem, it tends to be a good source of recurring revenue.

Amazon asserted its clout when it scored a big deal with the CIA. It beat out International Business Machines (NYSE:IBM), who was, for years, the established go-to company for the government, and credibility came with AWS's victory. According to Gartner, "No other company is really close to Amazon in terms of its offerings, but there are a variety of niche players." While Amazon dominates most things related to cloud, Microsoft is the dominate niche player. 

Big Blue buying its way into the game
IBM might have lost the CIA deal to Amazon, but it still remains a formidable force in cloud. It bought out SoftLayer for instance, in an effort to build out its public cloud infrastructure. IBM is focusing on the hybrid cloud, which makes it a direct competitor to Microsoft going forward. Amazon mostly focuses on the public cloud, thus avoiding the hybrid concept for the most part. Microsoft has already built out an enormous hybrid infrastructure, however, so IBM might have a tough time competing, especially if Azure is cheaper.

Still, there's room for more than one player in every market, and as a leader in IT, IBM seems like a natural fit for the hybrid cloud market. Some analysts think that by 2016 the hybrid cloud market will make up the majority of the IT market, so growth is there. Now its up to IBM to remain relevant as Microsoft increasingly expands into its turf. 

The bottom line
Microsoft is taking the lead in the hybrid cloud, and is integrating its popular enterprise products like Office into its cloud offerings. These older products are now being offered as subscription-based, reducing piracy and increasing lucrative streams of recurring revenue. Azure has quickly become a strong asset, and with Satya Nadella as CEO, he will be the perfect leader for the "new" Microsoft.

Until Microsoft proves themselves in the cloud, Bill Gates will fear these three companies
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Joseph Harry owns shares of International Business Machines and Microsoft. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com, International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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