Microsoft is unique from its peers as its cloud services were designed to serve the needs of large companies. This is particularly true with regards to Microsoft’s lead in hybrid cloud, which is attractive to many companies who are adopting cloud infrastructure for the first time, and who desire more flexibility than traditional cloud-only services can offer.
The company’s fiscal Q2 2020 earnings report today prove that Microsoft’s slow and steady focus on the enterprise customers is paying off. Operating income and net income were especially healthy, rising 35% and 38% on a GAAP basis, respectively, from a year earlier. Profits came in at $11.6 billion, and earnings-per-share of $1.51 were up 40%. Analysts polled by FactSet were expecting $1.32 per share on average.
The company is guiding for revenue of $34.1 billion to $34.9 billion in the fiscal third quarter, in-line with analyst estimates of $34.16 billion.
Looking beyond growth, this was also a banner quarter for Microsoft, who secured the Department of Defense’s $10 billion JEDI cloud contract. This contract will cover 1,700 data centers and move 3.4 million end users and 4 million endpoint devices off private servers and onto the cloud. Amazon is contesting the decision.
Advanced Micro Devices (AMD)’s stock price is up by 108% this year, making it the best-performing company in the S&P 500 this year. Its closest peer has been Nvidia, whose stock has climbed by 56%. Other peers like Intel, Broadcom, and Taiwan Semiconductor have gained by 22%, 24%, and 48% respectively year-to-date. As a result, AMD has helped power the Fidelity Select Semiconductors (FSELX), which has risen 48% this year, and the PHLX Semiconductor Sector Index (SOX), up 46% this year.
The main justification for the surge in AMD’s stock price is that the company is successfully taking market share from Intel – and to some extent, Nvidia. Since 2017, Intel has lost 10% of its PC CPU market share and 5% server market share to AMD.
Higher PC and graphics chips helped drive the most recent quarter’s performance, yet AMD’s strategy in the CPU-powered cloud-data center segment as the company takes on juggernaut-Intel is especially promising.
In the most-recent quarter, AMD reported revenue of $1.8 billion, which is the company’s highest quarterly sales in more than a decade. Revenue missed by $1 million on an expected $1.81 billion while the company met EPS forecasts of $0.18 EPS. Management guided fourth-quarter revenue of $2.05 billion to $2.15 billion, while analysts had forecast revenue of $2.15 billion. Factoring the past three quarters means that the company will likely generate $6.4 to $6.7 billion in revenue this year. This will be slightly flat from the $6.47 billion that was generated a year ago.
The issue is that the recent AMD share price surge and subsequent valuation multiples see it as a growth company. It has a one-year forward PE ratio of 36, compared to Nvidia’s 30, Taiwan Semiconductor at 20, and Broadcom at 12. Historically, the S&P 500 has an average forward PE ratio of 15. The current PE ratio for the AMD is 206, nearly 5x higher than Broadcom at 45, nearly 4x higher than Nvidia’s at 55 and an astonishing 8x higher than Taiwan’s current PE ratio at 25.
Meanwhile, AMD’s YoY revenue growth same quarter is at 8.95% and will be 52% growth YoY same-quarter Q4, if the company comes in at the $2.15 billion. (Hence the popularity of the stock and cyclical nature of semiconductors). YTD growth is around 20%, which is similar to Broadcom.
AMD’s fundamental story lies within the company’s margins, which historically, have been very low, and are impacted by average sales price (ASP), cost per unit and volume. The company’s trailing EBITDA margin of 8.35% is below that of peers mentioned above. However, over this past year, AMD’s non-GAAP margins have expanded even as revenue declined.
Intel, on the other hand, saw non-GAAP margins fall YoY. This helps support the bull case that AMD’s earnings are growing even while experiencing flattened revenue, and the company has forward-looking potential.
The main challenge with AMD’s current share price is market exuberance over the company’s rebound from the lowered guidance in July. In the technical analysis below, we attempt to reveal just how stretched AMD is, to make the case that now might be the time to take profits, or wait for confirmation if you are looking for an entry.
AMD’s Stock Price: Technical Analysis
Price is approaching a resistance zone that AMD has failed to break through twice over the prior 2 decades – once in the year 2000 and then again in 2006.
Regarding resistance and supports, the longer the region has held the more important it becomes. Also, the severity of the correction from the price region usually dictates the importance of the region as well. In other words, AMD has failed to breakthrough twice over a 20-year period at this region, and what followed these failed breakouts was two drawdowns greater than 90%. Therefore, this price zone is important for AMD to break through.
Notably, the short interest in AMD is currently around 11%, which is high. So, if AMD can break through this region, it will force shorts to cover, accelerating the price even higher. However, if AMD cannot breakthrough this zone, a healthy correction should be expected. History doesn’t always repeat, but it can rhyme, and a mere retrace to the 23.6% Fibonacci retrace level, a mild correction compared to the uptrend we’ve seen in AMD since 2016, would constitute around a 50% drawdown.
There is negative divergence between the RSI and MACD making lower highs while the price of AMD is making higher highs. The price is thus moving up while the buying pressure is fading. This is typically a sign of a fading rally and suggests a pullback is on the horizon. Furthermore, the price is rising on decreasing volume as well, suggesting that not many investors are buying at current prices.
This divergence is not only happening in AMD’s price, but across the Semis that are trading in the U.S.
The above chart is showing the Philadelphia Semiconductor Index (SOXX) compared to the South Korean Kospi Index. South Korea is an economy that is fueled by some of the world’s largest semi-conductor companies, as well as many mid-level players. Companies such as Samsung, and SK Hynix supplied over 60% of the components used in memory chips sold globally in 2018.
Therefore, the KOSPI provides important information about the global health of semiconductors. As you can see, these indexes are historically closely correlated. Today, we are seeing a very wide divergence between the U.S. semiconductor index and the KOSPI, which is unusual. This suggests that either the PHLX or the KOSPI will need to make a move to realign. My best guess based on the evidence is the U.S. semiconductors will point downward soon.
Regarding AMD, the volume suggests buyers are drying up at current prices, which makes sense considering the overhead resistance, fundamental outlook and global slow down. If I were long, I’d be looking to take profits at current prices, or at minimum buy insurance through a put.
I’m publishing this week on Microsoft – the full copy of the article is below.
This is a stock I have a decent track record on, as I encouraged investors to consider the company during the Q4 sell-off (about a month after the company had missed earnings).
I also pointed out in a separate analysis that it would be a strong contender for the Pentagon contract. I got a lot of backlash from a few AWS bulls who said I was wrong. A few months later, the DoD announced that Microsoft was in the running and now it’s widely believed the contract is between Amazon and Microsoft.
I hope my streak continues on this stock because I’m definitely swimming against the stream in my upcoming article this week. The point of the upcoming article is to make it clear that the projections for cloud growth are not in agreement with the current rotation out of cloud. In fact, the rotation is sending the wrong message as the best gains on cloud are predicted to happen over the next three years at an acceleration of 200-300% compared to the last decade (stats below).
My readers should remain flexible and be prepared to play this either way. If cloud rallies, or if cloud sells-off – make sure to have a strategy to get back in. If other tech companies come in weak over the next year, all the better to get cloud cheap. I am personally playing the cloud market right now while understanding the market will eventually fold its hand on these high valuations. I can’t perfectly time a market, so I prefer to play on trends that I know are in their prime. If the market doesn’t behave the way I want it to, I follow my stops and get back in. My biggest drop was Nvidia during the crypto bust — which retained gains because I had a stop. And, I believe in this company so I got back in.
Keep in mind, if Microsoft has a negative surprise, cloud stocks will get rocked. I do already own Microsoft as I was vocal about its strength during the Q4 selloff but I’m playing momentum in the short-term right now, as well. I can’t find any evidence that cloud is slowing down, so I’m sticking with what has worked in the past (numbers and facts, rather than the emotions of the market).
Gartner has been accurate in the past with their unbiased analysis on tech trends. I place more weight on Gartner than IDC. In fact, IDC has already been proven wrong this year with a forecast that cloud would grow 11%. Cloud has already grown 24% in the first half of 2019 with IaaS and PaaS growing at 44% and SaaS growing at 27%, according to Synergy. (Gartner is detailed in the second chart below)
Gartner’s take on the cloud market:
If you are not in Microsoft right now, and the valuation is too rich for you at a 25+ forward PE and P/S of 6-7, then Knox sees a broader market pullback opportunity at $92 down the line. For anyone in Microsoft, he sees $128.50 as support and $146.50 as the start of a renewed bullish trend. He has more detailed analysis coming out on this soon after earnings.
My full article on Microsoft is below the technical analysisMy full article on Microsoft is below the technical analysis
Microsoft Technical Analysis
By Knox Ridley
Though MSFT is trading flat with a decelerating RSI, relative to its cloud peers, its showing some strength. In other words, while most cloud stocks are down double digits, MSFT is simply flat.
It’s trading within an ascending triangle pattern, which more often than not, resolves to the upside. If you are going to play the long side, a safe stop would be just under $128.5.
I placed a series of supports that will act as significant regions in any significant pullback. Also, even in a major drawdown, the likelihood of MSFT retracing beyond its 23.6% retrace level is slim . Above the $146.5 region, and the bull market in MSFT should extend.
I will release a more detailed report of MSFT’s long term prospects soon.
Microsoft Article:
Headline: Microsoft’s earnings report will likely make believers out of cloud-software skeptics
Subheadline: The company is well-positioned for further gains, reflecting accelerating revenue growth in the industry.
Story:
Microsoft’s quarterly results to be released this week will tell us whether fears about the cloud-software industry are warranted.
Revenue growth in the cloud sector has been phenomenal and, according to research firm Gartner, is poised to accelerate.
Morgan Stanley and Evercore ISI analysts aren’t so bullish. They downgraded some cloud companies before they released earnings. The stock market showed tension cracks last week when Workday said human-capital-management-software growth was slowing to a 20% pace. Shares of Workday, Okta and Slack Technologies, among other companies, tumbled in response.
This week, we will see if the momentum from growth to value picks up steam. Don’t be surprised if cloud companies continue to report strong earnings. The goal for investors is to tune out the noise, as cloud-revenue growth is likely to defy the odds.
In a sweet spot
Microsoft is at an inflection point for cloud software (also known as SaaS) and cloud infrastructure (IaaS). Well-rewarded revenue growth in the cloud sector has taken more than a decade to accumulate, measuring a market worth $40 billion in IaaS and $95 billion in SaaS.
However, it will take only three years to double this revenue. Although many cloud stocks will reap those benefits, Microsoft is especially well-positioned.
According to Gartner, the cloud-services industry will grow at nearly three times the rate of overall IT services through 2022. Cloud infrastructure-as-a-service will grow at 27.5% in 2019 to $38.9 billion, and will reach 76.6 billion by 2022, or nearly 100% growth.
Other areas where Microsoft excels, including platform-as-a-service (PaaS) and SaaS, will also nearly double. This helps to cement Microsoft’s IaaS market share, as Gartner also predicts 90% of organizations will purchase public cloud IaaS and PaaS from a single provider.
Although it’s likely there will be some ups and downs on a quarterly basis, the market may be surprised to find that growth across the cloud industry occurs with, or without, a perfect economy.
This has been a challenging time for tech stocks, yet Microsoft’s shares have returned nearly 29% (with dividends reinvested) for one year through Oct. 18, compared with much lower returns for Amazon.com, Alphabet and Apple
Previous earnings reports
Microsoft’s stock has performed better because its hybrid cloud strategy began to take hold in 2018, two years after the first technical preview in 2016, and this spurred faster growth than the market estimated.
Last quarter, Microsoft beat revenue expectations by $920 million and the consensus earnings per share (EPS) estimate by $0.16. The company exceeded expectations handily in the two quarters before that as well.
Microsoft will report fiscal first-quarter results Oct. 23 after the market close. The company’s fiscal fourth quarter was its best yet for commercial cloud, with revenue increasing 39% year-over-year. Azure had the strongest growth at 64%, followed by Dynamics 365 at 45% and Office 365 Commercial at 31%.
Hybrid cloud requires a closer look, and not only because it’s been showing up in the financial statements under Azure. It’s important to consider what will set Microsoft apart from other cloud IaaS providers, including Amazon, the leader, and Google Cloud. This is key to forecasting future earnings.
Hybrid cloud allows for scenarios where customers can keep their most sensitive data on their own servers while sending workloads to the private or public cloud that gain an advantage from mining data more efficiently and require improved accuracy and productivity.
Azure’s strength in offering both on-premise and cloud in a hybrid solution has prompted Amazon to chase Microsoft with recent efforts to improve its hybrid strategy. Today, Azure claims more than 95% of the Fortune 500 as customers because of its hybrid flexibility.
Security is a key concern:
Understanding hybrid provides transparency into how managers of companies with big budgets think and how they evaluate the cloud. Security is clearly a concern as on-premise servers continue to be in demand as a counterpart to the public and private cloud.
The Department of Defense (DoD) is a perfect example of an entity that would want to keep its most secure data with on-premise servers while leveraging the cloud for artificial intelligence and machine learning. Fortune 500 companies with substantial intellectual property are additional examples.
I wrote a long-form analysis on why Microsoft would be a strong contender for a Pentagon contract when pundits had zeroed in on Oracle, IBM and Amazon. The contract is worth $10 billion over 10 years.
Beyond the $1 billion in annual revenue, it’s the implications of which company the Pentagon chooses that is most important. That’s because the winner likely has the best security.
There are many instances in recent years where the DoD chose Microsoft for software and operating systems. Recently, the Pentagon awarded Microsoft a $7.6 billion contract to provide software. The Defense Enterprise Office Solution (DEOS) will provide email, calendar, video-calling and productivity tools to the U.S. military.
In May 2018, the U.S. intelligence community extended its agreement to use Microsoft products such as Azure Government, Office 365 and Windows 10 in a joint licensing agreement with Dell. At the time, Microsoft said more than “10 million government customers from every federal cabinet level, including the Department of Defense” rely on its Cloud for Government.
In November 2018, Microsoft won a $480 million contract with the DoD to bring 100,000 augmented-reality headsets into the military’s arsenal. The two-year contract will help soldiers prepare for combat training.
There were more contracts in 2016 to provide technical support to the Defense Information Systems Agency (DISA) and a contract that took effect in 2017 to provide 4 million laptops, desktops and mobile devices.
Microsoft’s advantage:
There is no evidence that cloud revenue growth will slow in the short term. There could be minor earnings fluctuations, but the trend is carrying a lot of force, with projections to accelerate two to three times faster than what we’ve seen over the past decade. Microsoft is well-positioned across all cloud segments, and has an advantage with hybrid cloud solutions and security.
This week, Microsoft’s earnings will shed light on whether the fear over cloud valuations is warranted or not.
Just last week, IBM results showed that its cloud segment grew by just 14%, boosted by its Red Hat acquisition. In more signs of trouble in the industry, Workday (WDAY) stock declined sharply last week after the company said that growth in its once-lucrative human capital management was slowing to 20%. This led to analyst cuts from Stifel, Deutsche Bank, and RBC. Morgan Stanley (MS) and Evercore ISI analysts have also rushed to downgrade the cloud industry ahead of the busy earnings extravaganza. Companies like Slack, Okta, Splunk, and Salesforce have dropped by 27%, 25%, 20%, and 8% respectively in the past three months.
This week, Microsoft earnings will be important because they will provide a picture about whether this sell-off and pessimism is warranted. Microsoft is important because it is the biggest cloud computing company in the world. It’s impressive growth in cloud has pushed it to become the second-biggest company in the world with a valuation of more than $1.07 trillion. Don’t be surprised if the sector ignores the market sentiment and reports impressive earnings.
Microsoft will provide a good indication of the cloud sector because of its broad offerings. The company has a large portfolio of cloud software (SaaS) and cloud infrastructure (IaaS) products. The IaaS and SaaS industries have grown to almost $40 billion and $95 billion in the past decade. This growth is expected to accelerate in the coming years as global corporation and governments embrace the efficiency of cloud. The industry revenue could double in the next three years. Although there will be many winners in the cloud race, Microsoft is well-positioned because of its scale and its approach of the industry. Just this week, the company acquired Mover, a small company that will help it simplify and speed migration to Microsoft 365.
The cloud sector has had impressive growth in the past decade. This growth is just getting started. According to Gartner, cloud spending will accelerate at nearly three times the rate of the overall IT sector through 2022. The research firm expects IaaS sector to grow by 27.5% in 2019 to $38.9 billion. It is expected to reach $76.6 billion by 2022, which is an incredible growth.
Not only this, Gartner expects other cloud sectors like Platform-as-a-Service (PaaS) and SaaS to nearly double. Another estimation is that 90% of companies will purchase these products from a single company. As a market leader, with a diverse suite of PaaS, IaaS, and SaaS products, Microsoft will likely be a potential beneficiary in the cloud cycle.
To be clear. Quarterly results will be inconsistent. It has been like this in all fast-growing sectors.
The past few months have been challenging for technology stocks. Yet, Microsoft has been a better performer. In the past one year, Microsoft’s stock has soared by 27% compared to Amazon’s 1.2%, Alphabet’s 13%, and Apple’s 9.6%.
Microsoft has beaten its peers mostly because of its approach to the cloud sector. The company was early to embrace hybrid cloud strategy, which started to take hold in 2018. This was two years after the company’s first technical preview in 2016.
This growth has happened even as the company’s valuation has gotten cheaper. The company has a trailing PE ratio of 27.5, which is much lower than last year’s ratio of 46. This implies that the 27% stock gain has been well-earned.
In the past quarter, the company reported great results. Its revenue of $33.72 billion beat the consensus estimates by $920 million. The EPS rose to $1.37, which was 16 cents better than what the market was expecting. In the previous quarter, Microsoft’s revenue of $30.57 billion was $760 million higher than the consensus estimates. Since 2014, the company has had just one EPS miss and three revenue misses.
In the most-recent quarter, the company’s growth momentum continued. Commercial cloud grew by an annualized rate of 39% while Azure grew by 64%. Dynamics 365 grew by 45% while Office 365 grew by 31%. These are excellent numbers for a company that was ignored and ridiculed by the investment community.
Investors should pay close attention to hybrid cloud when looking at Microsoft. Looking at it carefully will give them perspectives about how the company is positioned to set itself apart from other cloud companies like Microsoft and Google.
Hybrid cloud is a technology which enables companies to store some of their data on their own servers while simultaneously sending other data to the private and public cloud. Companies love hybrid cloud because it is cost-efficient, transparent, and safe. Azure’s strength in hybrid computing has made it the main player in the industry. The product is used by 95% of Fortune 500companies.
Government agencies like the Department of Defense are starting to invest in this technology. Last year, I wrote a long-form article explaining why Microsoft would be a better contender for the $10 billion Joint Enterprise Defense Infrastructure (JEDI) contract. In August, the department, which had favored Amazon paused the procurement process on Amazon security concerns. There were also concerns over why single-sourcing was used for such a sensitive contract.
The decision by the DoD to pause means that Microsoft could be at play to win the contract. Microsoft is a leading contender because of its track record with the DoD. Recently, the department awarded the company a software computing contract worth about $7.6 billion. The Defense Enterprise Office Solution (DEOS) will provide productivity tools to the U.S. military.
Microsoft’s cloud products are also used widely in the country’s intelligence sector. In May 2018, the U.S. Intelligent Community announced that it would continue to use Microsoft’s products like Azure Government, Office 365 for US Government, and Windows 10. In the announcement, Microsoft said that its Microsoft Cloud for Government solutions were used by over 10 million government customers.
In 2018, the company won a $480 million contract to supply about 100k augmented reality devices to the US military. The company won this contract after competing with other companies like Magic Leap, Lockheed Martin, and Raytheon. The military bought these devices because it wanted to incorporate night vision and thermal sensing in its training.
The U.S. Department of Defense has partnered with Microsoft on more projects. This means that there is a possibility that the company could be a leading contender on the JEDI project.
Microsoft will release its Q1’20 earnings on Wednesday. Analysts expect the company’s earnings to increase to $1.24 from $1.14 a year ago. Revenue is expected to jump from $29.08 billion to $32.24 billion. As with all of its earnings, the market will be focusing on the cloud segment. There is no evidence that this revenue will slow down. While uncertainties on trade and economic growth could lead to some fluctuations, Microsoft has an advantage because of its cloud strategy and execution.
Last March, Nvidia announced an agreement to acquire Mellanox for a total enterprise value of $6.9 billion. Pursuant to the agreement, Nvidia will acquire all of the issued and outstanding common shares of Mellanox for $125 per share in cash.
I’ve covered the product details of this acquisition in detail with an analysis last April and one last week. To summarize, the Mellanox acquisition will help increase Nvidia’s competitive lead on GPUs, while also slightly reducing the requirement for CPUs from companies like Intel and AMD. Mellanox can be leveraged to speed up GPUs while closing the gap in latency performance with FPGAs (Xlinx and Intel/Altera). This is a strategic acquisition for Nvidia and Mellanox to become the strongest combination for artificial-intelligence and machine-learning computations. Nvidia beat out Intel and Microsoft in the bid for Mellanox.
Mellanox is trading below the $125 price at $108, time of writing. This is likely due to concerns the acquisition won’t be approved by Chinese regulators, similar to Qualcomm’s failed acquisition of NXP Semiconductors. The deal would have been the biggest semiconductor takeover globally at $44 billion. According to sources from China, the case was not approved for anti-monopoly reasons rather than trade-war tensions.
Nvidia and Mellanox are in separate categories and don’t pose security risks from communications, therefore, it is less likely this acquisition will be blocked. In addition, China is a large customer of Nvidia and stands to benefit from the combined company. China needs this acquisition for its sizable AI ambitions to reach a domestic AI market of $150 billion up from the $6.7 billion today. These plans were published in 2017.
We also see some company insider activity with Stephen Sanghi, a director at Mellanox, buying shares worth $2.2 million at $110 per share in June 2019. Sanghi is also the CEO of Microchip Technology. At this price, Sanghi will make 11.6% return with an annualized return of over 21% if it closes by the end of 2019.
The acquisition is an all-or-nothing gamble with technical analysis indicating shares could go as low as $72 if the acquisition is not approved. If the deal is approved, investors have a merger arbitrage worth about 15%.
My best guess is that China will not block this acquisition as it does not constitute a monopoly, is a much smaller company than NXP, and accelerates Nvidia’s product to compete with Intel/Altera, an acquisition that closed at $16.7 billion in 2015. This is a guess and is dependent on what Chinese regulators decide. From a tech product perspective, there are no obvious issues with regulatory approval.
Technical Analysis
By Knox Ridley
Price Action
Mellanox is currently in a strong uptrend, which we are able to track with the dark blue trend channel in the above graph. You’ll notice how well the price action respects this channel as both support and resistance through-out the move up as well as the slight retrace we are in now. Mellanox was already trading through the upper trend channel when the Nvidia acquisition was announced, causing the price to gap-up an then trade slightly higher. When a stock breaks through the initial trend channel with as much force as Mellanox has and then begins to retrace, we can draw a new channel to gauge the likely points of attraction for a further retrace as well as a new advance. You’ll be able to see this is the dotted blue lines in the above graph.
In short, the price is trending towards the $105 support level, which coincides closely with the 200-day moving average. Expect strong support here. The resistance is $121
Scenario 1: If we break the $105 support, there is not much support until the $91-$88 range, which coincides with the 38.2% retrace as well as the lower channel of the trendline. This will be very strong support for any additional retrace.
Scenario 2: The $105 trendline holds, and we maneuver to all new highs above the green resistance level, around $121. If the Nvidia deal is allowed to go through, which we believe it will, expect this move to be sudden.
Internal Strength
The internal strength, as outlined by the MACD, is currently in a weak spot. It turned hard on the current retrace and is making higher lows, which is a good sign for building momentum. As long as the MACD does not break the -2.4 line to make new lows, then we can expect the price to build momentum.
In 2019, the biggest cloud customer in the world will be the United States Department of Defense. The DoD is currently reviewing bids to award a single cloud provider a multi-year contract. Obviously, this isn’t your typical enterprise IT department, transferring from on-premise servers, or a startup who needs the flexibility of cloud infrastructure to scale. The program is called the Joint Enterprise Defense Initiative, or JEDI, and its purpose is to move the DoD’s massive computing systems into the cloud. This one contract is worth $10 billion, or 25% of the current market, which currently stands at $40 billion in annual revenue.
Many prognosticators and reporters unanimously believe the contract will go to Amazon Web Services. This belief is so strong that vendors, such as Oracle and IBM, made a rebuttal to Congress, believing the terms of the proposal favored Amazon. However, the majority of these forecasts overlook Microsoft’s strength in security and IT, and the alliances Microsoft has been forming with the DoD since Satya Nadella became CEO in 2014. Admittedly, guessing a company other than Amazon will win the Pentagon contract is a pure gamble, however, there are strong indicators for Microsoft that should not be overlooked
The Pentagon contract will move 3.4 million users and 4 million devices off private servers and into the cloud. The security risks of using servers outside the Pentagon’s domain are offset by physically separated government regions and hybrid solutions that extend on-premise servers by adding the cloud where necessary. The benefits of artificial intelligence, deep learning, and other technologies like virtual reality are essential for modern warfare as real-time data will inform missions when soldiers are in the field and also help to prepare them for combat.
“This program is truly about increasing the lethality of our department and providing the best resources to our men and women in uniform,” the Defense Department’s chief management officer, John H. Gibson II, told industry leaders and academics at a public event. Developing the system “will revolutionize how we fight and win wars.”
The DoD will not be the first to make a big move to the cloud. John Edwards, the CIO of the CIA, called moving to the cloud in 2013 ‘the best decision we’ve ever made.” According to Edwards, the 4,000 developers across the intelligence community work in the cloud environment, rather than individually provisioned workstations, which means the scalability does not come at the cost of the security. The Intelligence Community’s Cloud Services contract, called C2S for short, enhances security by not connecting to the internet. The results are better than expected as what used to take 180 days to provision a single server, improved to 60 days, and now takes a few minutes due to virtualization.
One point of contention during the request for proposals, released on July 26th, was the stipulation that the contract be awarded to a single cloud provider. This provision caused a rebuttal to be sent to Congress as it narrows down who can compete on these terms. There are nine tech companies who have voiced opposition to the government awarding the JEDI contract to a single provider, including Oracle, Microsoft, IBM, Dell, Hewlett-Packard, Red Hat, and VM Ware.
While some cloud providers argue it will make the JEDI program less secure to be with one provider, this isn’t necessarily true as working with multiple providers introduces new vulnerabilities. One reason for this is that “managing security and data accessibility between clouds currently requires manual configuration that is prone to human error or resource limitation and therefore introduces potential security vulnerabilities,” as stated in the Pentagon’s response.
There are further disadvantages to storing data in separate silos across multiple vendors, which can weaken machine learning and artificial intelligence capabilities, reduce training performance and lower accuracy. The DoD is seeking to remove data silos as they move from their legacy systems, which are scattered across 500 individual cloud efforts.
The Case for Amazon
Amazon’s significant market share is one reason it is favored to win the contract. To put it simply, Amazon has the infrastructure and security clearances to meet the proposal’s guidelines while the majority of cloud contenders are too specialized to contend, such as Oracle with its flagship databases, or VM Ware with virtual machines. These limitations ultimately prevent these companies from meeting all of the proposal’s criteria.
Proponents for Amazon also point to the CIA contract that was awarded to AWS in 2013, which was a $600 million computing contract that services all 17 agencies in the intelligence community. Notably, for the last five years, Amazon has proven it can manage sensitive government information. Last April, Defense secretary Jim Mattis praised Amazon to lawmakers at a hearing when he said, “We’ve examined what CIA achieved in terms of availability of data” and “also security of their data, and it’s very impressive.”
The CIA contract was decided in 2013, but it wasn’t until 2014 that Satya Nadella started his tenure as CEO that the MS cloud platform Azure began its rise. Nadella worked his way up through the company over the course of nineteen years to president of the cloud business. At this point, Nadella who is not backing down with recent Level 6 security clearances anticipated in Q1 2019, which will put Azure on par with AWS with top-level security (more on this below).
There are many instances in the last four years where the DoD continued to choose Microsoft for software and operating systems. For instance, in May of 2018, the United States Intelligence Community extended its agreement to use MS products such as Azure Government, Office 365 for US Government, and Windows 10 in a joint licensing agreement with Dell. In this announcement, MS stated that over “10 million government customers from every federal cabinet level, including the Department of Defense” rely on MS’s Cloud for Government.
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In 2016, MS won a five-year contract to provide technical support to the Defense Information Systems Agency (DISA). In 2016, the original Windows 10 agreement that took effect in 2017 included 4 million laptops, desktops and mobile devices. More recently, in November of 2018, MS won a $480 million contract with the U.S. government to bring 100,000 augmented reality headsets into the military’s arsenal. The two-year contract will help soldiers prepare for combat training.
The question that remains is if the Pentagon will want to use Amazon for cloud infrastructure while using Microsoft for operating systems and software? If the Pentagon truly wants one provider, then Microsoft can offer an end-to-end solution for the DoD. This will be especially important as we see edge device computing built out, which Microsoft is preparing for with Azure Sphere.
We can also see from the timeline of MS’s press releases that the company is preparing to be a strong contender with Amazon on security:
In early 2017, Microsoft granted access to the Azure Government Department of Defense regions at Impact Level-5*, per their website.
In August of 2018, MS announced that Azure Stack, the hybrid solution, is available for government customers. This allows customers to maintain their own data centers while using cloud services for its advantages.
MS announced Azure Government Secret in October of 2017, which helps U.S. agencies handle classified data in areas such as energy research or law enforcement.
In October of 2018, when the Pentagon contract bids were due, MS posted on its blog that by the first quarter of 2019, Azure Government Secret will support “Secret U.S. classified data or Defense Information Systems Agency (DISA) level 6 workloads*.”
*Level 5 security is what Microsoft currently holds while Level 6 is what will be required by the Pentagon and is what Amazon currently holds. Microsoft will achieve Level 6 by Q1 2019. Here is a snapshot of the different levels of security authorizations (image source: Defense Information Systems Agency)
Levels of Security Authorization Chart
Takeaway:
Microsoft has had a long relationship with the government that precedes the 2013 CIA contract. At the time of this contract, MS was not a cloud contender, but Satya Nadella was determined to change this. MS will soon be an apples-to-apples contender with AWS on security, hybrid solutions and government cloud regions. Meanwhile, MS has secured the operating systems and software used by the Pentagon, through licensing with Dell. If the DoD were to choose Amazon, they’d still have to work with Microsoft on security, and would technically be working with two vendors. However, if the Pentagon wants one provider for end-to-end cloud computing, software, operating systems, and edge device computing software such as Azure Sphere, then Microsoft is the clear choice.
The cloud infrastructure market is expected to reach $83.5 billion by 2021, up from $40.8 billion in 2018. Amazon Web Services was launched in 2006, which means it took twelve years for the infrastructure-as-a-service (IaaS) market to reach $40 billion – but will take only three years for the next $40 billion to accumulate. Therefore, the investment window for cloud infrastructure stocks is far from over.
The IaaS segment is currently Amazon’s most profitable revenue stream comprising 55% of its quarterly operating profit, and is also the top growth-driver for Microsoft at 89%. Considering these are two of the three companies vying for most valuable company in the United States, it’s easy to see why IaaS could be the determining factor on who will remain in this position. AWS has a formidable lead in cloud infrastructure with estimates of $26 billion in sales last year compared to Microsoft’s $10 billion.
However, there was an important strategic acquisition Microsoft completed last month which will narrow its position in second place – and it’s my prediction that this specific acquisition will be a primary driver that will propel MS into first place in the next 2-3 years. Before I discuss the acquisition, I think it’s important to provide an overview of the IaaS segment.
Gartner analysis bumped Oracle and IBM from the leader quadrant this year, while placing Google Cloud in third behind AWS and Microsoft. For all intents and purposes, these are the three cloud infrastructure companies remaining for serious stock investors after a period of fierce consolidation. At one point, Amazon had more market share than the trailing 14 cloud infrastructure companies combined. It now has the market share of the trailing 5 companies combined. This reflects Microsoft and Google’s growth as the territory Amazon has forfeited was primarily gained by MS Azure and also Google Cloud Platform (GCP).
AWS has an outstanding lead at 33% of the market, with Microsoft at 13% and Google at 5-6%. These margins are why Amazon posts 40% growth while Microsoft posts 98% growth – there is simply more territory that MS can gain as a second-place participant. GCP claims the most growth because its revenue is small enough to post these gains.
Suffice to say, current revenue is not a solid indicator of who will capture the $40 billion projected growth over the next three-year period. In fact, I believe AWS will have its hardest years ahead as Microsoft’s singular focus has been to grow Azure, and this strategy will be reflected in earnings between 2019-2022. AWS is the most mature provider in this category, but Microsoft has deeper experience with strategic IT dominance. The effort at which Microsoft is driving adoption to .NET CORE and Azure is, surprisingly, not something we see with AWS (more on this below).
To some extent, this reason could easily be explained by Amazon’s ever-expanding focus. The company may be too distracted with growing its e-commerce dominance, such as Prime deliveries and also Prime OTT streaming, plus the Whole Foods acquisition, as well as its plans to disrupt the healthcare industry and the connected home. It’s easy to see how Amazon might lack the focus in strategic investments that the competitive cloud infrastructure market will demand. Microsoft, on the other hand, is putting its entire weight behind IaaS, and the next couple of years will be interesting to see how this plays out.
Microsoft’s Strategic Move to Acquire the World’s Largest Open Source Repository
Microsoft’s dedication to become the cloud infrastructure leader was demonstrated last month with the acquisition of Github for $7.5 billion, which is a repository for developers to upload projects and files. There are 28 million active developers collaborating on GitHub. In other words, every single developer in the world is on GitHub. In fact, GitHub’s user base is larger than the total number of developers globally, which is an impossibility the founder pointed out last year, proving the platform’s omnipresence.
“Git” refers to version control systems, which developer-talk for an open version of all the modifications made to projects (like writing code), that is stored in one central repository. Collaboration and sharing are at the essence of open-source software, and Github provides a social environment for this to occur. There is a ton of innovation which happens here, and almost every developer hosts their code and projects here for the world to see (or even for employers to review during job interviews). Developers can “fork’ a project, or split a project, by creating a new project off an existing one. Or they can issue a pull request to have the original developers of a project incorporate new code.
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Ironic is the best word to describe Microsoft’s venture into open source technologies and repositories. At one time, the company was loathed by the developer community for their closed standards, as the Founder Bill Gates adamantly believed software should be proprietary. In the late 90s, leaked documents showed Microsoft had attempted to contain the open source movement, and to prevent Linux from competing with Microsoft software by locking customers into proprietary protocols. (Linux is the free and open-sourced software operating system that launched in the early 90s and Android is built on today; Windows is the anti-thesis to this operating system).
Developers seek open source environments so they can learn from each other, and to support more innovation. Today, AWS excels when it comes to open source development due to being an early supporter of Linux. However, Microsoft is attempting a complete one-eighty by embracing the open-source community, and if MS succeeds, it will pay in dividends for Azure as it goes head to head with AWS.
This venture into open-source advocacy has been planned for some time. Over the last few years, Microsoft became the top contributor on Github with 2 million projects, which helps position Microsoft as an advocate while evangelizing the .NET framework and the .NET CORE that runs on Windows, MacOS, and Linux. Microsoft now claims that 40% of Azure’s virtual machines are running Linux.
Furthermore, MS acquired Xamarin two years ago, the leading mobile application development platform. The tools help developers navigate across the various programming languages required by different platforms, such as iOS and Android on native, web applications, or a mix of both with 75% of the code re-usable. This greatly reduces development time and resources, and also demonstrates that MS is ready to host and support competing operating systems in order to gain on cloud infrastructure.
Takeaway: Microsoft is courting developers because they are a primary decision maker as to which cloud service a company will use. MS Azure’s current customers are enterprise level, such as Fortune 500 companies. Microsoft’s strength is that most businesses at this level have a significant investment in MS products, and it is easier to go with MS because it is what they know, and the transition is easy as the IT department won’t have to be trained on AWS or Google Cloud.
However, Microsoft’s blaring weakness is open source, and the some 28 million developers that are on smaller teams, and who socialize on Github, are decidedly open source. For $7.5 billion, Microsoft has done what every great company should do – acquire to address your weakness.
Both Xamarin and Github are highly strategic acquisitions. Microsoft paid 25 times the value of Github, which has revenue of about $300 million. Alphabet was also interested in purchasing Github, according to inside sources.
Summary: Infrastructure as a service (IaaS) is the fastest growing cloud segment and will continue to be with AI, machine learning and connected cars. Gartner, an authority in tech analysis, placed Oracle in the “niche player quadrant” (not the leader quadrant) for Infrastructure as a Service (IaaS) May 22. In addition to IaaS, Oracle’s Data as a Service business model will weaken as marketers fail to get proper consent for ad targeting.
Cloud infrastructure is hot right now and for good reason. The world increasingly relies on cloud data centers due to server virtualization, smartphones, movies and entertainment, chatbots, office productivity, software as a service, and social media, to name a few.
Gartner predicts the worldwide public cloud services market will grow to 21.4 percent in 2018 to $186.4 billion. The fastest growing segment is infrastructure as a service (IaaS) forecast to grow 35.9 percent in 2018. As we store more data in the cloud from AI and machine learning, this sector will continue to expand. For instance, fully automated cars will produce an estimated 25 Gigabytes of data per hour or 300 TB per year. Therefore, any savvy investor should place bets in this sector for 2021 and beyond.
No Medal for 4th Place in Cloud Infrastructure
Oracle (ORCL) is a long-time enterprise cloud powerhouse with billions invested in engineering and strategic acquisitions. On the quest to build and defend a range of cloud services, the company is expanding hybrid-cloud technologies, investing in customer-success programs, and benefiting from a less-than-expected decline in on-premise revenue. On the other hand, the transition to the cloud is taking longer than expected, according to Keybanc analysts, and is at risk for lagging behind Amazon (AMZN), Microsoft (MSFT) and Google (GOOG) in the Infrastructure as a Service category, the fastest growing category in public cloud services.
Last quarter, Oracle beat earnings estimates but came in slightly below expectations for revenue at $9.77 billion vs. $9.78 billion. The adjusted earnings of 83 cents beat the consensus estimate of 72 cents and was up 20% for its fiscal third quarter, which ended February 28. The better than expected earnings were not enough to convince investors in Q3 as the stock fell 4 percent after earnings were reported, then fell an additional 8 percent in pre-market trading. The stock is at $46.16 today compared to $52.90 before Q3 earnings.
One major concern is Oracle’s low share of cloud infrastructure and platform revenue, which came in at $415 million with 28 percent growth compared to Amazon at $5.11 billion revenue at 45 percent growth. It doesn’t help that Gartner, an authority for accurate tech analysis, placed Oracle in the “niche player quadrant” in the Magic Quadrant (not the leader quadrant) for Infrastructure as a Service (IaaS). Notably, financial analysts from JP Morgan and Murphy lowered Oracle targets yesterday, however, Gartner published this magic quadrant on May 22nd and it is likely what these analysts based their predictions on.
Meanwhile, in another category, cloud software (SaaS) revenue was up 33% last quarter for Oracle at $1.15 billion with notable competitors SAP and SalesForce. The remaining revenue is primarily on-premise revenue of $6.42 billion, and software license revenue of $1.39 billion.
While Oracle has maintained a name for itself in cloud services, it’s offerings are not strong enough to earn a medal as a front runner, which will spell trouble for earnings as Data as a Service (DaaS) undergoes regulations.
DaaS: Programmatic Will Crash
Oracle pursues many strategies and acquisitions for cloud services because it knows it has to be seen as a cloud company in order for Wall Street to invest in its future. However, one of Oracle’s main market positions is Data as a Service (DaaS). From 2012 to 2014, Oracle went on a tear of acquisitions to increase their marketing stack and to cement their position in the digital advertising space. In May of 2012, Oracle bought social marketing solutions provider Virtue for an estimated $300 million, the marketing automation firm Eloqua for $810 million in December of 2012, Responsys for $1.5 billion which is a business to consumer solution and the data management platform, BlueKai, for $400 million in 2014. This totaled an estimated $3 billion in collective marketing tech acquisitions to enhance DaaS.
Programmatic is the automatic trading of advertising which is augmented by data for superior digital advertising. Oracle’s DaaS is essentially a way for companies to upload their data and potentially enrich their data by anonymously sharing and matching data sets. Oracle calls this “making your data smarter.”
Notably, BlueKai was a private company that captured the data boom with 9,245% growth from 2009-2012 – although competitors in the market saw a whopping 21,337% revenue growth (Data Xu). BlueKai was originally a buyer and seller of consumer data and pivoted to become a seller of data analytics and management technologies. These acquisitions were designed to help Oracle enable private data sharing. This is where the marketing ecosystem ingests first-party data and brokers marketing communications (MarCom) and advertisements in a second- party data transaction. While the data is not being sold, the information is being shared to third-parties without consent for the purpose of more advertisements.
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As the Oracle BlueKai deck states, here are some examples:
Hotel chain sharing data with a bank to target customers who do not have bank rewards cards
Online broker sharing data with a social media site for audience based targeting
Social media site sharing data with a technology company
While Oracle Blue Kai may not come directly under regulation because they are the middleman, and not the company with a direct relationship to the user, their business model is likely to weaken due to the way the data is being used. Marketing platforms and data management platforms will increase a marketers liability if they choose to transfer and trade private, first-party data. For these marketers, under the GDPR, consent must be given for each processing operation need and cannot be bundled together. Therefore, there will be less advertising and Marcom data to process, lowering Oracle’s revenue.
My Prediction: Cloud infrastructure will continue to grow as data storage increasingly provides the infrastructure for technological advancement. Amazon, Microsoft and now Google have been upgraded while Oracle has been downgraded during a key growth stage for IaaS. In addition, Oracle acquired many companies in the DaaS space which will continue to wane as regulations increase on customers using Oracle for targeted data. Couple this with fierce competitors in the IaaS and SaaS space, and Oracle will see lower than expected earnings this year.
Prior to the advent of mobile computing, security was limited to corporate IT assets that were often physically secured in facilities owned and managed by the company. According to a recent SANS Institute study, organizations spend as much as 12 percent of their IT budget on security.
In a Ponemon Institute study, it was found that organizations have a 27.7 percent probability of having a material data breach in the next 24 months at an average cost of $3.62M.
Meanwhile, the world of computing has changed. Security is not just about physically secure data centers and corporate controlled computing assets. Instead, end users have gone mobile, connecting to cloud enabled services, often with their own personal devices. And with the rise of the Internet of Things, there will be billions of connected computing devices on the planet in the next several years.
The primary consequences of applications getting hacked include financial loss, destroyed brand reputation, exposure to liability, and regulatory risk. Over 7 billion identities have been stolen in data breaches over the last eight years equal to one data breach for every person on the planet. Meanwhile, mobile’s rapid expansion has introduced a complicated and potentially hostile environment that is difficult to manage and protect.
64 percent of security practitioners said they were very concerned about the use of insecure mobile applications in the workplace with an average of 472 mobile applications reported as actively used in organizations.
Prior to the advent of mobile computing, security was limited to corporate IT assets that were often physically secured in facilities owned and managed by the company, on a network behind a managed firewall, and possibly in a datacenter with multi-factor access, physical security, and armed guards. Because the company owned those assets, they were able to dictate what applications could run on those machines, and actively manage and monitor them, providing the latest patches, endpoint security, and other controls dictated by corporate IT. Assets located in such places were implicitly trusted.
Today, the situation has changed. Mobile devices dominate the market, often as the primary or only way users access the Internet and the many cloud services available. These devices also have very little, if any, physical security. It is a well-worn path hackers use to access such devices to reverse engineer or tamper with the applications running on them, often through rooting, jailbreaking or hoodwinking the user.
This shift has created all sorts of new business models to take advantage of the popularity of mobile devices.
These new business models come with new security problems:
New forms of payment using near field communications (NFC) on mobile devices are becoming popular in recent years. These applications require that credentials to authenticate users must be stored on the device. If those credentials are compromised, then a hacker can execute fraudulent transactions.
Mobile devices are being used in the automotive industry to enable remote parking from your smartphone. A compromise of the device could pose a serious safety risk.
In healthcare, patients are using mobile devices to manage sensitive information collected from various devices ranging from fitness monitors to blood glucose monitors to improve care and create data driven treatment options. A compromise of such a device can lead to a loss of privacy and sensitive information. Or even worse, if a device is hacked, it could potentially lead to life-threatening consequences for the patient.
Internet of Things
By 2025, the total global worth of IoT technology will reach USD 6.2 trillion with the most value coming from health care devices (USD 2.5 trillion) and manufacturing (USD 2.3 trillion). Meanwhile, we see a persistent lack of IoT security investment with 67 percent of medical device makers expecting an attack on their devices while only 17 percent taking measures to prevent an attack. These numbers are staggering when you consider U.S. hospitals have an average of 10 to 15 connected devices per bed with some hospitals registering 5,000 beds — totaling 50,000 connected devices per hospital.
Furthermore, traditional security solutions do not port well to the IoT world, due to differences in system architectures and resource constraints. Therefore, IoT security solutions have not evolved enough and are prone to numerous vulnerabilities.
