In this episode of Industry Focus: Tech, The Motley Fool's Dylan Lewis and Tim Beyers give a breakdown of various components in the cloud space in an easy-to-understand form. They look at some leaders and some promising companies operating in this space. Discover more about their operations and future growth potential and so much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Feb. 28, 2020.

This video was recorded on Feb. 28, 2020.

Austin Morgan: Hey, everyone, it's Austin again, coming at you to let you know that this episode was also recorded at the end of February, as Dylan is still on vacation. So, there's no mention of the recent news or volatile week in the market; that's why. Timing, am I right? Enjoy!

Dylan Lewis: It's Friday, March 13th, and we're talking about the cloud. I'm your host Dylan Lewis, and I'm joined by Motley Fool premium analyst, Tim Beyers. Tim, Friday the 13th, you feeling a little worried, like a little superstitious?

Tim Beyers: The coronavirus is hitting us around the world; so, yeah, I am feeling a little superstitious here, Dylan, I'd be lying if I said I wasn't.

Lewis: Yeah, I think that's a very reasonable and measured approach to have. Certainly, we've seen the stock market react to the coronavirus; maybe feel a little superstitious as well. Do you have any superstitions that you uphold, any, you know, not breaking mirrors or avoiding cracks in the sidewalk?

Beyers: I do avoid cracks in the sidewalk. I think that is just a habit. I don't know why that is, but I got a little -- you know, I'd look down when I was a kid, and I'm like, I'm just going to jump over every one of these things. And I still think I unconsciously do that as an adult.

Lewis: [laughs] Well, it's one of those things, like, if you're walking down the street with your parents or something like that, as a kid you got to turn everything into a game, right? So, you wind up popping over the cracks and all that kind of stuff. I'm with you on that one, Tim. And I figure it's better, it's probably better to be on the more structurally sound part of the sidewalk anyways.

Beyers: Oh, totally. Yeah, I don't want to fall into any cracks; not in the stock market and certainly not on a sidewalk.

Lewis: Yeah, I grew up reading Shel Silverstein, I know how that story ends, I don't need to see it. Austin, our producer, any superstitions for you?

Morgan: Aside from all of the baseball ones, [laughs] one that's always stuck with me is lifting your feet going over a railroad track.

Lewis: Yeah. I think I subconsciously do that.

Morgan: Yeah, it's just something, I never even think about, but I noticed it, like, last year, I think. I was like, "Oh, that's weird."

Lewis: [laughs] I have a friend who holds his breath when he rides through tunnels and when he rides near cemeteries. And it's great, as long as he's not the one driving. It becomes problematic when he's the one who's driving the car. So, in any event, I hope everyone's having a nice, safe Friday the 13th, and maybe listen to a little Stevie Wonder, some Superstition, to get yourself rid of any bad omens or anything like that.

Well, Tim, the reason I'm having you on the show today is, we want to talk about the cloud and really give a holistic overview of the cloud, and you are "the" cloud guy at The Motley Fool, you're the Lead Advisor of our cloud service.

Beyers: Yeah, we call it Cloud Disruptors 2020, it's part of the Discovery universe, which is Tom Gardner's universe of stock picking services. It's a real money portfolio. We launched it in January and we're really excited about it.

And what we think is the thesis that we have for this is that the cloud is bigger than you think it is. And we find very often, Dylan, that investors and people that are writing about the cloud or thinking about the cloud, they conflate it with Software-as-a-Service; and so, basically anything that is software that you access in a browser. So, Salesforce.com (NYSE:CRM) is maybe the poster child for this, but that also includes things like Zoom and Slack and other companies that we like here at The Motley Fool.

So, we think you should be considering the cloud in a much broader way. So, we think you should think about it as, like, if you stood up a subdivision and you were a construction company. And if you wanted to set up a subdivision, there are a lot of things you would do. You would connect to the water utility and the electric utility; you'd make sure there were roads to where you wanted to build. And so, we consider all of the things that go into what builds out a subdivision and the houses that go into that. And we think there are six categories in the cloud that, sort of, define this. So, when you start all the way out at the utilities, and the roads and, sort of, paving those roads. That's what we call components and connectivity.

So, that's semiconductors, the chips that go into servers, the service themselves, the networking gear that allows the internet to come into a data center, which is No. 2. A data center is like the factory of the modern internet economy. There are lots of servers stacked together. We use them here at The Motley Fool; lots of companies use them. So, when you're connecting to the cloud, really, you're connecting to some hardware somewhere. And almost inevitably that hardware is housed in a data center. So, that's the second link in the value-chain.

The third link is what we call Infrastructure-as-a-Service, and these are the public clouds. So, that's Amazon (NASDAQ:AMZN) Web Services, that's a Google Cloud [Alphabet] (NASDAQ:GOOG) (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT) Azure. And these are big companies. They provide a lot of services; the basic infrastructure. And there, that's like, when you start -- when you've got roads, you've got utilities, you've got someplace, you've got land where you can put houses. Once you get that set up, you're going to set up the plots, and on those plots, you're going to build foundations. That's infrastructure. And when it's in the cloud, it's Infrastructure-as-a-Service.

Then on top of that, you have what's called a platform. And Platform-as-a-Service is, if you thought about any platform -- a platform is something you build something on top of -- so, the best way to think about that, everybody has got a computer and if you have a Mac, macOS is your platform; if you have a Windows machine, Windows is your platform. It's the stuff that developers use to write software.

So, here, just continuing the analogy, that would be, like, the wood or the drywall; the things that you have for a basic structure that turns materials into just a house. And then, from all of that, then you can make an actual house; you can make a home. And that's the interior work. So, all of this stuff, this infrastructure Salesforce uses to show you a product that allows you to track customer leads and things like that. And so, that's like the bathtub, the sinks, all of the things that turn a house into a home.

And, of course, all of the people you need to build these things are the contractors. And so, we think the sixth link in the value chain is service and support. So, those are the contractors, those are the consultants. And they're akin to the construction contractors; people who actually build these homes.

So, we think you should be thinking broader about it. When we looked out at the market, what we saw is, at best, companies, investors that were investing in the cloud or maybe putting out an ETF were investing maybe in Software-as-a-Service, maybe some Infrastructure-as-a-Service, a couple of platform companies, but nothing else. And by missing those other three links in the value chain -- the components and connectivity, the data centers and the service and support providers -- I think you miss a huge amount of potential alpha, the potential upside in investing in the cloud.

So, our service is built around these six links. And we think it's the right approach, still early, but we're convinced that we've got it right.

Lewis: Well, I love myself a good metaphor, and I think this is a very nice and tidy and complete one, Tim. So, thank you for that. I think you're 100% right. You know, so much of the conversation that we have around the cloud, even on the show, is really focused on the Software-as-a-Service business. I think, thanks to the likes of Salesforce, people are becoming a little bit more aware of the power of those models and how successful some of those software companies can be when they leverage the cloud.

You probably have some other folks that are really familiar with the Infrastructure-as-a-Service, what you were talking about before, because of AWS. I think that's probably one of the easiest things for people to know about, even if you don't actively follow the cloud industry and technology, just because it became such a large story and such a large part of the Amazon investing thesis over the last couple of years.

Beyers: There's no doubt. And it's very easy to get lost in those big names, and we know the big names. So, AWS -- And let's be clear, this is growing incredibly fast. I did a little back of the napkin math, I don't want to get too into the weeds here, Dylan, because I know we only have so much time. But when I did the math, it's pretty easy to see how AWS could be valued as a $400 billion company. And that's staggering. If you thought about that and then you looked at Amazon today; it's about a $1 trillion valuation. So, what if that's roughly right. So, then, $400 billion is AWS and $600 billion is the mammoth that is the rest of Amazon.com. What does that say?

First of all, it says two things to me. First, that Amazon is an amazing business that's growing very quickly, but also that the cloud is so important; it has such economic power. And while Amazon is certainly leading in this space, -- it is the leading Infrastructure-as-a-Service provider -- the fastest growing is Microsoft with Azure at 62% year-over-year in the last quarter. And right behind them is Google Cloud at up 52%.

I think one of the things you can think about, if you wanted to really understand this is, think about what developers need. So, let's go back to the metaphor. So, what does a contractor that's building a house, what do they need? They need a lot of different things. And so, the infrastructure you need, like, concrete, you need piping, you need all of these things. So, when you think about AWS, that's what it provides. Google Cloud, same thing; Azure, the same thing. In order to pour a foundation and do it really well and have it be steady, you need these things.

So, in the software world, a developer will pull these pieces of infrastructure that are available through Amazon Web Services by swiping a credit card. They'll pull a tool, let's say, well, I need to write a transactional system and I'll pull these three tools from AWS to do that. That's what infrastructure does. And on a platform, say, like Office 365, that's another platform that we all use for productivity software. It's also Software-as-a-Service. But all of these things, sort of, fit together for the purpose of creating software that we can use every day.

So, kind of the best way to think about this is, what do developers use? And if they're using it, there's a really good chance it's going to create value and potentially long-term returns.

Lewis: One of the reasons why I like this value chain breakdown that you provided was the marketplace within each of the sub-industries is so different. Infrastructure-as-a-Service, we talked about before, but Amazon Web Services, Microsoft Azure, Google Cloud, those are the big three and the rest of the market is a very tiny portion when you look at market share.

Very different story when you look over at Software-as-a-Service, for example. You have the giants, the Adobes and the Salesforces of the world, and then you have a lot of companies that have built out a really nice smaller business servicing a niche that has more specific application.

Beyers: Right. And I can mention one, one that we really like that's in the Cloud Disruptors service is called Anaplan (NYSE:PLAN), and the ticker is PLAN. And this is a company that is dedicated only to doing business planning. And so, it exists in the cloud, and the idea is that when you're writing business plans, if you're a CFO and you say... our CFO, Kerra McDonough, will ask different business units within The Motley Fool to roll-up their numbers and come up with a plan and a budget and things like that.

And most often, I honestly don't know how we do it here, but in most companies that's usually an Excel spreadsheet and each business unit is creating an Excel spreadsheet. And then it gets passed around and then somebody on Kerra's team, or the CFO's team, is responsible for rolling that up into one master monster Frankenstein spreadsheet. And it's a nightmare.

And one of the things that that can happen in that scenario is, say, you start the budgeting process in June and you need to be done and have the budget ready by September, but you're still budgeting in January of the next year because it takes so much time to reconcile those spreadsheets. So, what Anaplan does in the cloud is, because everybody is on one instance, everything's in the cloud, all of these plans get developed concurrently and they get reconciled concurrently. So, it's connected. And because it's connected, it goes faster, it's more efficient, it's less error-prone.

And we really like this business. And what we're seeing is that big companies that need to solve this problem are writing big checks and they're writing more big checks. And so, they've created essentially a giant backlog at Anaplan. They have about $319 million. It's not a big company in terms of revenue, but their backlog is almost triple that. That's pretty amazing.

So, if you're talking about a company that's actually writing longer-term contracts, that gives you some insight into how much faith customers have in the business. And frankly, that's how Salesforce really got traction. It would write these really long-term contracts, lots of deferred revenue. And by deferred revenue, we just mean revenue that a company has said, "Okay, I've committed to buy in year three," but Salesforce, in signing that contract, can't really say that that's revenue that's booked yet, it's just revenue that's coming and it is very unlikely to get cancelled, that's what deferred revenue can be.

So, anyway, Anaplan really fits this model. It's a little bit like Salesforce in that regard. I'm hesitant to use the comparison there, because, really, there's only one Salesforce, but in terms of how this company is growing, it's a little bit reminiscent of that; we like it a lot.

Lewis: Yeah, that's a heavy comparison. Anyone that follows the Software-as-a-Service space knows, I mean, that is the company that really created Software-as-a-Service as we know it and kind of created the gold standard for how to operate a business like that.

Okay, so that checks the Software-as-a-Service portion of this value chain. I also want to talk a little bit about Platform-as-a-Service. I think sometimes the two of these can kind of get combined together, Tim.

Beyers: They really can Infrastructure-as-a-Service/Platform-as-a-Service get confused a lot, because what's the difference between, where's the line between, like, OK -- So, go back to the metaphor. Aren't I going to be building? While I'm standing up 2x4s and I'm trying to build the structure, the skeleton of the house, probably going to be laying pipe too, right? So, I'm going to be building some infrastructure and a platform basically at the same time. And, yes, that's true.

So, these things do get confused. And it is also fair to say that Microsoft, Amazon and Google, the three biggest Infrastructure-as-a-Service providers, also provide some Platforms-as-a-Service. I'll give you one example of that that is a little bit technical, but bear with me for a second.

So, Google, a few years ago, created an open source technology called Kubernetes. And essentially, all Kubernetes does is it orchestrates; it's basically like a conductor. If you thought of these components, these things called containers, as players in an orchestra, Kubernetes is the conductor. And so, containers are really simple. They are little bundles of software that can be self-contained. And what makes Kubernetes so powerful is it allows you to orchestrate as many of these containers as you want. And so, it's kind of like a platform, and that exists inside Google Cloud platform. So, it's an Infrastructure-as-a-Service and it's a Platform-as-a-Service.

Now, there are companies, though, that are independent and they really are platform providers. And one of my favorites -- and, Dylan, I know you talked about this, I think, with Joey on a previous podcast. You know, we talked about Datadog (NASDAQ:DDOG). Datadog; I mean, the dog has got bite. It's a great company. It's growing very quickly. The way to think about Datadog -- and I know listeners are probably going to be familiar with this, but the way I think about it is it solves a really big problem for developers. When you go in and you could stand up a dashboard and you could see, like, where is my code failing or where is it slow, and then it points you to that. And so, as an IT management team, so a CIO can say, "You know what, I can see where the problem is," and then talk to developers, and they can fix it.

Instead of, the way it used to be is, well, we're having a problem and we don't know whose fault it is. Is it the CIO's team that demanded some new workflow and now the thing that we thought we built for one reason is now being used in an entirely different way? And so, the developers did nothing wrong but the CIO's team is to blame, or is there an error in the code and we don't know which it is?

And so, Datadog solves that problem. It uncovers where the problem is, and then developers and IT teams can get to the business of solving it together. And that's something that the founders of Datadog saw very early. It speaks to a very common problem, especially inside companies that are growing very quickly, and consequently, Datadog is growing very, very quickly.

It's a smart solution. We use it here and our developers love it. And while that's anecdotal, I usually find that if you talk to developers, and even a small sample set, and they say, not just, "Yeah," but they say, "Oh, no, we really can't live without this." That's a signal. You need to do more research than that, but that's a really powerful signal in a lot of instances and we're getting that at Datadog.

Lewis: A 100%, Tim. I mean, I think you could say the same for a company like Twilio. You know that was a developer's best friend type company. Something that made it a lot easier; kind of, gave people the building blocks to work all of this communication functionality into apps and things like that.

The real selling point for me with Datadog being a wonderful business is that net expansion rate number. We talk about it all the time with as-a-Service companies; it's basically their comps number. And I remember, when Datadog went public that number was around a 140% which is just remarkable. What's incredible too about this business is a lot of hype because of that number and because of some of the crazy growth, and they doubled year-over-year right before they went public, when it came to their revenue.

This has actually been a stock that has held up with their valuation. They weren't one of the 2019 IPOs that nosedived as soon as they reached the public markets. So, the results continue for them. They continue to put up great numbers and clearly the growth story is intact.

Beyers: Oh, 100%. And not only is the growth story intact, but what that net expansion rate tells you is that customers are relying more and more on Datadog. That's what we like about that metric. And you're right, the best way to think about it is; so, restaurants have foot traffic and they measure comparable store sales from the year before. And that's what a net expansion rate is, you take the cohort of customers from a year prior. If they're still around, what are they spending? Are they spending more? And if it's 146%, which I'm pretty sure that's what Datadog was when it came public, that means they're spending 46% more. That's extraordinary.

And when a company can take its existing members and generate so much more revenue just off of its existing customer base, that's amazing. You don't have to do a lot of heavy-lifting with new customers when your existing customers are relying on you more. And so, this is a usage-based model. Customers are doing more with Datadog. I don't see any reason why they're not going to continue doing that. That is something to watch, by the way. So, one of the beauties of the SaaS model, or just the as-a-Service model, in general, a lot of these companies, because they are subscriptions, you know they depend on being able to sell a customer, keep them and sell them more over time. And the ones to do this really well -- you mentioned, Twilio, they've been great at it; Datadog is really good at it. Fastly is another one, their ticker is FSLY; has been really great at that over time.

So, you want to keep watching these companies win a customer and then grow with them over time. The SaaS companies, and all of the as-a-Service companies, tend to really be obsessive about this metric, and for good reason. If they're doing it well then you can really bank on that growth. It's just easier to forecast continuing growth when they're able to keep customers embedded in the system and using it more often.

Lewis: So, Tim, a lot of our conversation has been focused on the as-a-Service, you know we talked about Infrastructure-as-a-Service with all of the cloud providers, platform, and now Software-as-a-Service as well. Do you find that that's where most of the interesting investable ideas within the cloud are, or are there things over in the data center and component side that are also interesting to you?

Beyers: All of it is very interesting to me. So, I don't want to over generalize. I think, one of the things that we see, and where we're kind of pivoting a little bit differently, is Software-as-a-Service is not overwrought, I would say, but, you know, where it gets interesting is that we know that market. You know, there are a lot of Software-as-a-Service companies. So, you have to dig a little deeper, you have to go looking for a company like Anaplan which isn't really as well-known.

But in Infrastructure-as-a-Service and Platform-as-a-Service, I think those are amazing opportunities. And frankly, as giant as Amazon is, I think that's an amazing opportunity. In fact, I've already gone on record elsewhere, so I'll go on record here too, and say that I believe that Amazon will be the first $2 trillion tech company, and maybe the first $2 trillion company, period, just because of the value of Amazon Web Services. I see that happening. So, I think there's a lot of upside for that business.

But I also think, to answer your question, man, there's a ton of opportunity in data centers, and components and connectivity, and in the service and support providers. Especially, actually, in the service and support providers, because they kind of just get thrown away, which is really unfortunate.

So, let's just take one, this is another one we have in Cloud Disruptors, Accenture. Which doesn't seem like a disruptor at all, because it's such a massive company based in Ireland, it's been around for years: the former Arthur Andersen. But here's the thing, Accenture does an extraordinary number of cloud-centric projects for really large companies around the world, and helping companies get set up and stand up new clouds, new projects in the cloud, and they're also doing innovations inside their own company, and then publishing the software that they create into a very popular repository owned by Microsoft, it's called GitHub. And GitHub is where a lot of developers go.

Again, let's keep the metaphor going; that's the toolbelt. So, if you're a developer, if you're a contractor you go to GitHub to get the tool you need to do the particular job that you need to do in order to get the house done. That's where you go and get tools. And a lot of them are open source. And so, Accenture has developers, they're just throwing software into GitHub and they're doing it all the time.

And some of the really interesting companies that do this well, Datadog is another good one. Datadog has a lot of good stuff that they're piling into GitHub. And that's something to watch, but I'll talk about in a second. But just finishing up on Accenture. I think, if you are looking at services companies, these contractors, they have very sustainable, long-term relationships with big companies and that's very stable revenue. And so, they can pay stable dividends without sacrificing a lot of growth.

I think the same thing is true in the data center businesses. So, you have a company like Equinix, which has a lot of customers. They pull these customers into their data centers and then they connect those customers together inside their data centers. And so, there's a built-in incentive to stay in your Equinix contract over the very long-term. And so, they just keep piling up recurring revenue, just year-after-year-after-year.

And of course, it's a REIT, you know, it's a Real Estate Investment Trust, so they return 90% of their profits to investors as dividends. So, you get some growth but you also get some income. And what we like about this approach of having just, not only the software disruptors, but also these other providers around them, not only do you get the whole value chain but you get some growth, you get some income, you get some stability. And it doesn't look like the stock market, so it's not really, exactly correlated to, say, the returns of the S&P 500. And that can be useful too, if you're an investor that's really looking to outperform over the really long-term.

So, I do want to say one thing, this is just, if you happen to be somebody who's interested in the tech space and you want to kind of understand a little bit what the investors are looking at, do yourself a favor, and google sometime, just take your company that you're looking at and, say, like take "Datadog, GitHub" and just enter that and do a google search. Look at what Datadog is putting on GitHub. And when you see a number of those repositories. And a lot of them have 300, 500, +1,000 stars, and basically that's like the Facebook "like," the "thumbs up" of the software. That tells you that, boy! developers really like this stuff. It's just a way to get a sense of the pulse of what developers are really interested in. So, just try that sometime. It's anecdotal, it's not something that's going to give you a perfect signal, but it's the kind of thing that we look at when we're looking at what developers really care about when they're building software.

Lewis: Yeah, Tim, I mean, that reminds me of looking at the Glassdoor reviews for the companies that you might be buying stock in, right? You know, you're looking for all these indicators, especially in a space where expertise is a little harder to come by. You know, if you're not a developer, that world can be very intimidating. But to be able to look and just try to find signals for what's the quality of this business' work? Do people like working there? We always like having these little ways to approximate that, and I think that's a great tip.

Beyers: Yeah, absolutely.

Lewis: Well, I think, we've exhausted the value chain of the cloud, or at least for this conversation. I'll probably bring you back on to talk about some more cloud winners that you like, Tim. Thank you so much for hopping on today's show.

Beyers: Yeah, that's great. Thanks a lot, Dylan, good to talk with you again.

Lewis: Alright. Listeners that's going to do it for this episode of Industry Focus. If you have any questions you want to reach out and say, "Hey," shoot us an email at IndustryFocus@fool.com or tweet us @MFIndustryFocus.

And as a reminder, listeners, if you want some stock ideas and recommendations, you can check out our Stock Advisor service. Get stock recommendations from David and Tom Gardner every month, your Best Buys Now and a whole lot more, and get all that at IF.fool.com. There's a special 50% off discount for our listeners over at IF.fool.com.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for all his work behind the glass today. For Tim Beyers, I'm Dylan Lewis, thanks for listening and Fool on!