By Delphine Blanche and Raphaël Pariente, portfolio managers at Montpensier Finance
With estimated annual growth prospects of 20% by 2030, the Cloud industry is built on solid fundamentals, as economic players have not fully grasped its advantages. Accompanied by strong cybersecurity needs and the rise of artificial intelligence, the theme deserves attention, especially considering that valuations were relatively attractive at the end of last year.
In the collective consciousness, the Cloud industry is often associated with innovative SaaS software, enabling individuals and organizations to store and access numerous files, applications, and data on the go. Over the past decade, interest in the Cloud has been growing, fuelled by the digitalization efforts of economic players and the democratization of new social practices and emerging uses (social networks, streaming platforms, virtual reality, etc.).
The adoption of this technology has also accelerated significantly during the Covid period, especially with the widespread adoption of telecommuting, the growth of e-commerce, and the increasing need for cybersecurity. In this context, spending on public Cloud services increased by 29% in 2020 and 31% in 2021.
In addition to all these elements, the Cloud industry encompasses a much broader range of other segments. Indeed, this technology relies on data centers, networks, platforms, as well as a multitude of semiconductors necessary for its proper functioning and performance.
With the strong growth recorded and expected in digital data volumes—181 zettabytes, or 181,000 trillion gigabytes, by 2025, representing a 3x increase in five years—the storage and computing capacities inherent to the entire Cloud infrastructure become a crucial issue.
Thus, the Cloud market’s prospects, which has already multiplied in size by 9x between 2013 and 2022 to reach $500 billion (approximately €464 billion), are still well-oriented. The Montpensier Finance teams estimate it to be over $2.1 trillion (approximately €1.948 trillion) by 2030. This progression implies a growth potential of about 20% per year.
Performance Gains for Businesses…
From a technical standpoint, the Cloud business model offers organizations of all sizes numerous economic advantages. On one hand, by outsourcing their servers, organizations can optimize their IT budgets by reducing costs related to on-site infrastructure maintenance and energy consumption. On the other hand, the capacities of SaaS software are scalable based on the end users’ specific needs. In this sense, companies can easily and quickly adjust their subscriptions to accommodate the dynamics of their activities. The scalability of the SaaS model ensures structural cost savings; the total cost of ownership of a Cloud structure is, on average, about 70% lower than traditional IT systems.
The Cloud is also a factor in achieving high productivity gains. The proliferation of collaborative SaaS software improves team management and efficiency. Well-known examples include DocuSign for electronic signatures, Teams for video conferencing, or Adobe for content creation; however, other players specializing in task automation, access security, or IT performance observability are becoming increasingly necessary for the smooth operation of a growing number of organizations. For instance, Dynatrace solutions, a software intelligence platform for DevOps (developers and system administrators), on average, deliver productivity gains of 40%, reducing incident detection time by 90% and false alerts by 95%.
… Still Under-equipped, Just Like Governments
Although Cloud technology has numerous advantages, its penetration rate is still relatively low. Cloud spending represents only 11% of global IT spending. Furthermore, the use of the Cloud is still mainly limited to data storage, office applications, or emails. According to a Eurostat study, only 24% of companies use the Cloud for ERP (Enterprise Resource Planning) applications, 21% for software development, and 58% in the field of cybersecurity. There is, therefore, a significant latent demand, providing Cloud players with new growth opportunities.
It is worth noting that the acceleration of the transition to Cloud technology is also driven by public and government agencies, which see innovative solutions to simplify their administrative processes, strengthen platform security, and limit social and tax fraud. In the United States, federal spending on Cloud services increased by 23% last year. This momentum could even accelerate with the proliferation of mega-contracts, such as the one signed in 2022 between the NSA, the U.S. intelligence agency, and Amazon Web Services, for an amount of $10 billion (approximately €9.3 billion), aimed at modernizing its analytical capabilities.
Cybersecurity and Artificial Intelligence Challenges
In addition to this structurally positive momentum, the Cloud is expected to benefit from other powerful growth catalysts. The increased need for cybersecurity appears as the first driver. In recent years, organizations and individuals have experienced a significant increase in the number of cyberattacks (+600% during the Covid period and +38% in 2022) due to the democratization of new uses, such as remote work, and the rise of geopolitical tensions.
Faced with these increasingly perilous and sophisticated threats, economic players have made cybersecurity a top priority by constantly increasing their budgets for information security. In June 2022, the United States announced a total allocation of $15.6 billion (€14.6 billion) for cybersecurity, distributed between the Department of Defense and the Cybersecurity and Infrastructure Security Agency, along with the creation of five teams exclusively dedicated to the project.
Ultimately, the cybersecurity market (see chart above) is estimated to reach $400 billion by 2026 (€371 billion), almost double its current level. Therefore, the outlook is favorable for the Cloud theme, which fully encompasses this sector. Moreover, Cloud technology also implies the development of protection solutions adapted to this new IT environment, including network and connection security (SASE), access management (Zero Trust), and incident detection (Cloud Monitoring).
The other element is the advent, in late 2022-early 2023, of generative artificial intelligence (GenAI). The enthusiasm around ChatGPT, OpenAI’s conversational agent, and its one hundred million active users just two months after its launch have been the most striking example. Many companies have successfully positioned themselves in this emerging segment with high growth potential. For example, Adobe launched Firefly in September 2023, an AI-based image creation software.
Beyond the remarkable technological achievement, GenAI represents an additional lever for productivity, offering a number of opportunities that are still challenging to quantify in many areas of economic activity. The total GenAI market (see chart below) is estimated to reach $1.3 trillion by 2032 (€1.206 trillion), implying an annual growth rate of over 40%.
Cloud companies positioned in the development of analytical solutions, database management, and the infrastructure necessary for increased computing power are expected to be the main beneficiaries of this surge.
More Attractive Valuations
Regarding stock valuations, the appreciation of the theme recorded since the beginning of the year is, in fact, a normalization linked to the de-rating of 2022. As of December 6, 2023 (Bloomberg-Montpensier Finance), the average EV/Sales of the universe has decreased by nearly -66% compared to the peak in January 2022, and it has returned to its ten-year average, reaching a level below 5x sales. The example is even more striking when looking at the relative expensiveness of the Cloud universe compared to the Nasdaq. Indeed, the EV/Sales Cloud has returned to comparable levels with the Nasdaq, or even slightly lower, with a relative rate of 0.93!
These elements tend to show that the stock appreciation recorded in recent months only reflects relative appreciation (see chart below). We have returned to normative bases with valuations in line with their historical levels. Therefore, the potential for financial and stock growth still seems high, especially as the challenges related to rising interest rates appear to be stabilizing.
The Cloud sector is based on multi-decade mega-trends that lead us to believe that we are still at the dawn of the growth potential of the theme.
Investing in the Theme
Montpensier Finance’s Fund, M Cloud Leader SRI, Article 9 SFDR, and SRI 5, aims to capture companies with innovative and disruptive technology in this space while focusing on those with a profitable financial profile, cash generation, good visibility on their activities, and a well-constructed development strategy. Montpensier Finance’s approach is focused on identifying three types of company profiles:
- ‘Leaders,’ which include historical Cloud companies that have been pioneers in its development and have a quality financial profile. These players remain pillars, given the consensus tools and resources provided to capture the market, especially in absorbing promising new companies.
- ‘Challengers,’ with values showing strong growth dynamics and having reached a certain level of profitability. The products offered remain best-in-class in their fields and bring more specificity to their customer approaches.
- ‘Climbers,’ meaning rapidly growing companies still in the early stages of development with potential for profitability improvement. Emphasis is placed on launching new products and strengthening sales efforts to make a name for themselves in their preferred areas. Collaborations may be in place to reduce costs and gain recognition more quickly.
After analyzing fundamentals, aligning interests with shareholders, and considering ESG principles, the result is a portfolio construction of thirty to forty positions.