The way of how we do business and work in our day to day life changed dramatically in the wake of the pandemic. Employees leaving their usual workplace and turning their homes into private offices required a switch to a more remote style of work. This, of course, comes with increased demand for cloud solutions which are critical for collaborating with co-workers and teams.
As a consequence, the stock prices of cloud providers skyrocketed since the start of the pandemic. The “Global X Cloud Computing ETF” outperformed the broader stock market 11-fold (Ponczek, 2020) which indicates the extreme demand of investors to participate in the trend. At the same time, cloud IPOs are more popular than ever before. The most recent example is the data-warehouse company Snowflake Inc. The start-up raised $3.4bn in its IPO in September, doubled its valuation to $90bn on the first day of trading while generating a loss of 348.5m at only $264.7m of revenues in the recent year (Henderson and Kruppa, 2020). Notably, Berkshire Hathaway also participated in the IPO what shows confidence in the business model since the fund historically stayed away from such offerings (Henderson and Kruppa, 2020).
For many analysts, it seems that mentioning “cloud” in your business plan already gives you a higher valuation (Ponczek, 2020), similar to the dot-com bubble when hundreds of start-ups raced to be the next digital champion. Also keep in mind that in 2019 already, some cloud stock traded at 17x the projected revenue, exceeding the already high valuations of other tech stocks (Ovide, 2019). Cloud is the future, but it is questionable whether there is enough space for all of those rising stars in the market.
Although the pandemic has accelerated the shift to working from home and the general need for cloud solutions, the fear of a similar burst of a bubble as in 2001 remains. What do you think? Can cloud companies justify their sky-high valuations and deliver value on the long term or is the trend hype-driven?
References
Henderson, R. and Kruppa, M., 2020. Snowflake doubles in first trades after largest-ever software IPO. Available at: https://www.ft.com/content/eb8e37c9-b4a5-4b4c-a3cf-2eeac98a8f2b [Accessed Oct 9,].
Ovide, S. 2019. Forget the FAANGs. Pay Attention to the Highflying PUTINs. Bloomberg.com, Available at: https://www.bloomberg.com/opinion/articles/2019-02-28/forget-faangs-stock-bubble-could-be-in-cloud-software [Accessed Oct 9, 2020].
Ponczek, S. 2020. Cloud Stock Mania Comes With Eerie Echoes of Dot-Com Boom and Bust. Bloomberg.com, Available at: https://www.bloomberg.com/news/articles/2020-10-08/stock-market-cloud-company-shares-ipos-see-boom-amid-covid-pandemic [Accessed Oct 9, 2020].
Hi Andreas,
Thanks for your article. Personally, I do not think the valuations of cloud companies is hype driven. Investing is about looking at future cashflows. Looking at the business models and the market these companies operate in, the Cloud services are there to stay for the coming years. Another thing investors love: membership models. Because these companies work with Cloud as a Service, they have a steady flow of recurring revenue.
So in general, one could say the valuations are justified. However, with high rewared, there comes high risk. It would be no surprise if one of the companies that now had a stunnishing IPO, would be not existing anymore in 10 years. Investing in an ETF would be much safer in that sense.
Last point, how to deal with the big tech-companies. Google, Amazone and Microsoft already moved on the cloud business, and gained a significant market share. Are new entrants able to co-exist with these companies, or are they forced out of the market.
It’s interesting how much of the startup industry is driven by hype. I actually wrote a blog post about the hype of AI startups, and how mentioing AI in your business model can give you a 15% higher valuation. Cloud is an interesting one, because I do think it still has a lot of potential, look at AWS. But as a VC, I probably too would push for an IPO and cash-out on the current hype. The entire world is working from home right now and suddenly the masses became aware of the importance of the cloud.