General Electric Company's (GE +0.42%) recently announced partnership with Microsoft Corporation (MSFT 2.17%) makes GE's cloud based platform-as-a-service (PaaS) Predix available on Microsoft's cloud service Azure. The deal between the two iconic blue chips makes great copy, but what does it mean for the investment case for General Electric stock?
General Electric Company is connecting railroads to the industrial internet. Image source: GE Digital.
Establishing the Predix platform
General Electric has been aggressive in making its PaaS solution accessible to customers -- Predix is already available on Amazon Web Services and Oracle's cloud -- and the partnership with Microsoft is clearly an attempt to further enhance Predix's leading position in the industrial internet. For Microsoft, the partnership marks an acceleration of its attempts to focus the company's offerings toward the cloud.
Competition between the major cloud platform providers will remain intense, but General Electric won't really mind how its customers reach Predix. The important thing is to establish it as the de facto standard for the industrial internet. Moreover, the more customers who are are using the Predix platform, the more likely developers will design applications and services on it, and with an expanded ecosystem, Predix will be more attractive to customers. With this in mind, it's clear General Electric needs to establish scale, and that's where the Microsoft deal comes in.
Why it matters
But, I digress. The key question is, how does this make General Electric stock more attractive?
The answer lies in understanding what expanding usage of the Predix PaaS can do to boost General Electric's revenue and profitability in future:
- Ability to sell analytics services from the data captured by Predix
- Enhance customer relationships and lead to increased services revenue (its services revenue tends to be higher-margin than product) for General Electric.
- The analytics capability of Predix could lead General Electric to use the feedback from customers usage and then change hardware products to better suit their needs -- giving General Electric an edge over its competition.
- Integration of hardware and Predix makes General Electric's hardware solutions more attractive to customers.
- General Electric could potentially service other customers' hardware, and Predix creates an added value to the proposition.
Alongside these factors, which primarily impact the top- ine, General Electric also has the opportunity to use the industrial internet to increase productivity with its own developmental and manufacturing activities.
Expanding revenue
Of course, all of these arguments can seem somewhat esoteric at the moment. Or at least they will do until General Electric can demonstrate significantly enhanced profitability from its software activities. However, that time may come sooner than many analysts think. For example, at General Electric's recent digital investor meeting CFO Jeff Bornstein outlined how revenue was set to grow:
In 2015, we had about $5 billion of revenue in software applications, hardware, software-enabled upgrades, etc., and we believe in 2016 we're going to grow that to more than $6 billion, and by 2020, we believe we'll grow that to something that looks like $15 billion.
To put these figures into context, the company's total revenue in 2015 was around $117.4 billion, so software-related revenue represented around 4.2%. However, Bornstein's projections could easily see the company generating more than 10% of its revenue from software-related activities within the next few years. If General Electric is going to get there, it will need partnerships such as the deal with Microsoft.
Moreover, end-market conditions look favorable for the both companies' ambitions. For example, industry-leading IT research company Gartner sees total endpoint spending on the Internet of Things rising from $1183 billion in 2015 to $3010 billion in 2020. In fact, Gartner sees endpoint spending rising at a 20% growth rate from 2016-2020. If General Electric is generating, say 10% of its revenue from activities related to the Internet of Things, and matches the 20% growth rate going forward, then it's not hard to see how the company can meaningfully increase its long-term revenue growth rate.
Where next for General Electric?
All told, the Microsoft partnership is part of General Electric's ongoing expansion with its industrial internet offerings, and as discussed above, it's also part of the company's ongoing shift to higher-margin services offerings. Ultimately, it's good news for stockholders. The benefits may not appear obvious right now, but it's only a matter of time before General Electric's positioning for first-mover advantage by investing in Predix starts to pay off significantly.
