There are no guarantees in investing, but the growth of cloud computing is as sure a bet as one can make for the upcoming decade. The pandemic accelerated what was already a big shift among businesses moving many of their computing workloads to the public cloud. Research firm Gartner projects overall cloud services to grow 23.1% this year and 19.6% next year, reaching nearly $400 billion in spending across cloud-based infrastructure, platforms, software, security, and business process spend.
Many tech companies are going after this market, but this summer, Amazon.com (AMZN 2.61%), Splunk (SPLK +0.00%), and Zendesk (ZEN +0.00%) each look like solid long-term buys after their stocks took a breather this earnings season.
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Amazon: The leader of the pack
Amazon invented the concept of cloud computing during the early 2000s, and had a multiyear head-start in building out Amazon Web Services, the world's largest and most comprehensive cloud infrastructure platform. Despite having far and away the most market share, AWS is still accelerating its growth more than a decade later.
Last quarter, AWS revenue accelerated 37%, up from 32% in the prior quarter and 29% in the prior-year quarter. At a $60 billion run-rate, that's hugely impressive, and indicates the enterprise transition to the cloud is still in its early stages.
The strong growth in AWS, along with huge growth in Amazon's digital advertising segment, seems to have been overshadowed by the deceleration in the company's first-party e-commerce business, which is the largest segment by revenue and drove down the company's overall top-line. Amazon's stock therefore fell after its second quarter earnings report, and its stock has trailed the S&P 500 by about 30 percentage points over the past 12 months.
Yet after such a long period of consolidation, now may be a good time to pick up shares. After all, the company's highest-profit businesses are AWS and digital advertising, which are also growing the fastest. Since the intrinsic value of any business is the present value of all future cash flows, not revenue, AWS and digital ads could account for practically all of Amazon's market cap today. Ever an innovator, Amazon's shares look like a solid buy after such a long malaise.
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Splunk: A business model change leads to opportunity
Another compelling cloud stock at a very reasonable price is Splunk. Splunk makes a variety of observability software services to monitor the health of an enterprise's IT infrastructure, network, and security posture, among others. As the digitization of the enterprise takes hold this decade, that will mean more and more inputs to monitor and manage, which should mean long-term tailwinds for observability software providers like Splunk.
However, Splunk's stock is down some 35% from all-time highs set back about one year ago. The likely culprit is a slowdown in the company's revenue growth, along with fears of higher interest rates, which can take a bite out of growth stock valuations.
But that revenue headwind is not a result the core business, but rather the company's transition from selling perpetual licenses deployed in customer data centers to a subscription-based, cloud-based software-as-a-service model more in line with the modern IT industry.
When a company transitions from a perpetual license to a subscription-based model, revenue will take a temporary hit. That's because perpetual licenses, designed to last many years, have all their revenue recognized upfront, whereas as SaaS businesses recognize revenue gradually over the length of the subscription. Splunk, founded in 2003 before the advent of cloud, was behind the curve on cloud for years, but began to get its act together over two years ago, when it began this necessary transition.
So while revenue grew just 16% last quarter, total annual recurring revenue (ARR) which incorporates recurring cloud subscriptions, was up 39% -- likely, much more indicative of the health of the business. Cloud-based ARR was up an even greater 83%. Cloud-based bookings just exceeded 50% of the company's total software bookings, which should portend better top-line results going forward, as Splunk's transition has now gotten through its "awkward stage."
The stock's discounted price, combined with good news on the business model transition, recently attracted private equity firm Silver Lake to invest $1 billion in Splunk, in the form of convertible notes. Kenneth Hao, Chairman and Managing Partner of Silver Lake, said in the press release:
We have long admired Splunk's world-class team and technology, and we believe the company is now at an important inflection point... It has become increasingly clear that a cloud-driven transformation is critical to modernization and Splunk is ideally positioned to help organizations throughout the world manage the complexity associated with this transition.
Silver Lake's convertible notes convert to common stock at a $160 stock price, compared with the $144 price today. Silver Lake likely hopes to make a big return off its investment, so there's a good chance the stock does quite well over the next few years as its cloud transition takes hold.
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Zendesk: cloud-based customer service is the future
Another cloud winner that sold off after its recent earnings report, but which appears to have a very bright future, is Zendesk, which offers a variety of cloud-based software services geared for customer service applications.
Zendesk slightly missed analyst expectations last quarter, but that's a tad misleading. Management attributed the miss to a couple factors; namely deals closing later in the quarter, which hit revenue, along with some one-time gains in the prior year quarter due to the onset of the pandemic, which made comparisons difficult.
Yet the underlying drivers of Zendesk's business appear intact. Revenue grew 29%, accelerating over the prior quarter's 26% growth. The company's net expansion rate, which monitors growth from existing customers, also accelerated to 120%, up from 114% in the prior quarter.
Importantly, though Zendesk started off as a popular solution for small businesses, it's catching on with larger enterprises. The percentage of large accounts paying Zendesk $250,000 or more per year has doubled from 17% in 2017 to 35% last quarter. And the company's new comprehensive Zendesk Suite, which offers all of Zendesk's services, from customer service to customer relationship management tools to other APIs, has also caught on. In fact, Zendesk Suite accounted for 16% of the company's annual recurring revenue last quarter, more than double that of the prior quarter. Landing larger accounts opting for the entire Zendesk Suite should go a long way toward maintaining high retention, keeping Zendesk's net expansion rate stable for some time to come.
Basically, the prior quarter was short on headline revenue numbers, but if you look under the hood, Zendesk's business actually appears quite strong. Trading at a price-to-sales ratio of just 12.5 -- relatively low, for the SaaS industry -- and Zendesk's post-earnings dip could be an opportunity to pick up shares of this cloud software winner.
