Equinix, Rackspace Riding Cloud Computing Wave

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To the average Internet user, it is an invisible revolution.

Newer, faster and more efficient concepts for how to structure and manage networks are rapidly altering the light-speed maze through which consumers and businesses work, play and communicate online.

Cloud computing is a trend consolidating Internet computing power in vast armories referred to as server farms. Another trend, Big Data, describes the tech world's effort not just to manage, but to make useful the rising waves of information gathering in digital coffers worldwide.

The convergence of those trends is creating lucrative opportunities for fresh armies of tech companies. Demand is hot for hosted data centers, networking equipment and software solutions: anything that helps companies save money on information technology while speeding access to and processing of their mountains of data.

"The technology industry is in the early rounds of a massive secular shift that will change the way businesses consume IT,"Rackspace ( RAX ) CEO Lanham Napier said on a conference call with analysts Aug. 7. "Massive technology disruptions like this create opportunities for companies to seize the moment, disrupt the status quo, and lead to revolution. We believe Rackspace faces one of those opportunities and that we are in a position to lead this revolution."

IBD's Internet networking solutions industry group is home to Rackspace and 29 other companies, many of which revolve around cloud-based services. The group ranks No. 57 out of 197 industry groups tracked by IBD. Its index is up 36% for the year, the sixth-best gain among all industry groups.

The data center providersEquinix ( EQIX ) and Rackspace Hosting have played a large role in that gain. So has network management software firmSolarWinds ( SWI ), as well as the website publishing and marketing companyWeb.com Group ( WWWW ).

Business

Market research firm IDC estimates that spending on cloud computing will top $40 billion worldwide this year and reach $99 billion in 2016. Rival researcher Gartner sees public cloud services generating $58 billion this year and $117 billion in 2016.

That's creating business opportunities for data center operators, like Rackspace andInterxion ( INXN ). Another hot spot is firms that optimize and speed the delivery of applications, video and other data online, such asF5 Networks (FFIV) andAkamai Technologies (AKAM).

Meanwhile, virtualization technologies, which multiply server capacity, are rapidly reducing the number of servers needed to power networks. That lowers the cost of Internet cloud-based computing, boosting service providers' cash flow and opening the door to more potential customers.

Cisco estimates that global Internet data traffic will rise from 43.4 exabytes monthly this year to 110.3 exabytes a month in 2016. An exabyte is equal to 1 billion gigabytes.

Network management software providers like SolarWinds andInfoblox (BLOX) must continually innovate in order to scale their offerings to new and rising levels of traffic. A large share of the rising Internet buzz is being driven by mobile devices, namely smartphones and tablets.

That is helping the cloud computing space expand at a more rapid rate than the overall IT industry.

"IT services (are) a sector that grows at GDP plus 1% a year and yet we are seeing the data center services companies like Equinix and Rackspace growing around 20% a year," said Evercore Partners analyst Jonathan Schildkraut. "What's going on is a major paradigm shift in the way that companies purchase, manage and access IT resources. And these companies are leaders in this paradigm change."

Market

Companies in the space compete by focusing on niche markets or offering lower prices or better service than rivals.

For instance, Equinix concentrates on lightning-fast data centers serving multiple customers or industries and located near key markets. Its customers are typically top-tier corporations that demand the highest performance, such asApple (AAPL),AT&T (T),BT (BT) andIBM (IBM).

A horse of a different color, Web.com, has carved out a niche serving small businesses. It has more than 3 million customers for its website hosting, domain name registration, online marketing and other online services.

A typical Web.com customer is a plumber, electrician or restaurant owner who is too busy to master search engine optimization, social media and online marketing. They turn to Web.com because their online presence isn't generating traffic and business leads.

The Internet is a big place and no one industry group contains all the innovative companies that make it work.

Networking hardware companies likeCisco Systems (CSCO) andJuniper Networks (JNPR) belong to the computer networking group.

Climate

A big part of the attraction of cloud computing is that it saves companies money by allowing them to pay for computing resources as a service.

"IT budgets have been relatively flat and chief information officers have been tasked with getting the same productivity out of the same sort of budgets," said Benchmark Co. analyst James Dobson. "One way to do that is to look for lower-cost alternatives, and outsourcing through co-location or cloud and managed hosting (are among) the ways they've been able to do it."

SolarWinds has enticed many customers with its cheap software for monitoring servers and networks.

"These guys have a very low-cost business model," said JG Capital analyst Jeff Gaggin. "They're beating companies like CA and BMC on a regular basis."

SolarWinds software doesn't have all the functionality of that offered by such larger rivals, but it sells for about a tenth the price. "It allows more affordable IT service management solutions," Gaggin said.

One of SolarWinds' cost advantages is its use of lower-paid salespeople, he says. And its marketing efforts are focused on online advertising where customers are researching IT management topics.

Technology

Rackspace is aiming to shake up the IT industry by using an open-source cloud operating system based on OpenStack technology. Open-source programs are, in effect, publicly owned, not copyright protected and generally in a constant state of evolving improvement.

Rackspace touts its technology as an alternative to proprietary brands that lock customers into a static product. It competes with proprietary cloud operating systems such asAmazon (AMZN) Web Services.

Other competitors, such asInternap (INAP), have also joined the OpenStack movement. Rackspace hopes to differentiate its offering through superior customer service, Napier says.

San Antonio-based Rackspace runs computer and data center operations for more than 190,000 customers worldwide.

Outlook

IDC predicts that spending on public IT cloud services will rise at a compound annual rate of 26% over the next five years. That's five times the expected growth rate of the IT industry overall.

It expects the U.S. will remain the largest market for public cloud services, followed by Western Europe and the Asia-Pacific region, excluding Japan. The fastest growth in cloud services, however, will be in the emerging markets, including China, India and Indonesia.

Meanwhile, Cisco predicts global Internet data traffic will increase threefold over the next five years. It forecasts compound annual growth of 29% in the next five years.

Demand for cloud computing resources continues to grow apace and so is capital investment in the sector, Dobson says.

"The main driver is the digitization of the economy," he said, "and we think that's in its early stages."



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: EQIX , INXN , RAX , SWI , WWWW

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