Rise of the Cloud - Have European Investors Underestimated its Potential? | SKYY
While US investors have started to pour considerable
assets into Cloud technology companies since beginning of 2019, Europeans have
ignored this sector altogether so far. What is the reason for this divergence
and who made the better decision? In order to decide this question, our
analysis looks at the fundamentals underpinning the Cloud sector and its
potential future growth drivers, as well as its historical financial performance.
Clouds are Gathering across the Pond...
Investors who are already familiar with thematic investments
and who are monitoring the multitude of available funds in this space, might
have noticed that one particular theme has started to attract a rapidly increasing
flow of net new assets in 2019. The theme in question is broadly referred to as
the Cloud. And it is not a particularly new theme. The first ETF tracking this
sector was launched in the US back in 2011. It quickly attracted inflows from
early movers, but it took until 2017 for investors to truly start believing in
the Cloud’s potential. As depicted in figure 1. assets in Cloud ETFs globally
more than quadrupled over the period 2017-2019 reaching $2.7 bn. However, not
all investors seem equally convinced yet. Taking a closer look at the
geographic distribution of inflows, we can see a stark divide between US and
European investors. Literally 99% of assets went into US domiciled ETFs and are
likely held by local investors, with European ETFs currently only amounting to
$26m. This divergence cannot be explained by a lack of availability as
investors in both regions are already able to choose from three different ETFs
tracking the Cloud sector.
Figure 1. Assets in US and European based Cloud ETFs (as of September 2019).
Source: HANetf, Bloomberg, 08. September 2019.
So, What is Causing this Divergence?
Are US investors too optimistic about the Cloud, or have
Europeans simply not yet embraced or maybe realised this sector’s potential? One reason might be US investors’ proximity to companies
from the Cloud sector. Out of the top 50 Cloud companies, more than 90% are
based in North America, with the remainder mostly in Asia. Investors in North
America will be more likely to encounter news about these companies in the
local media and hence be more aware of the sector’s development and its
positive outlook. Also, investors tend to exhibit home bias when investing and hence
might be prone to focus their efforts more on local companies, which again
would explain why US investors might have realised the potential of cloud
companies earlier than investors in other geographic regions.
Cloud ETFs - Hype or Reality? Taking a Look at the Fundamentals
Just
because a sub-set of investors decides to invest in a particular group of companies
does not mean that others should blindly follow. Sometimes when being too close
to a particularly trendy subject, one can get blindsided by exuberant media
reports and overly optimistic growth estimates. So let’s take a look at the
fundamentals underlying the Cloud sector in order to evaluate the recent vote
of confidence from US investors
Figure 2. shows revenue estimates for the sector for the
next five years. There are two observations to be made. First, as of 2018,
revenues for the sector amounted to $184bn. As an absolute value this is a high
number and shows that the sector is already a fundamental part of the wider
Information Technology industry. Second, and more important for investors, the
sector also shows a high and steady estimated growth rate of 16% for the next
couple of years. This number is particularly strong when viewed in the context
that the Cloud is not a fundamentally new technology, but it represents a
redistribution of existing IT expenditures. Instead of spending money on internal
IT, companies can now pay specialised Cloud companies who manage their IT needs
in a more secure, scalable and cost-efficient manner. As a result, Cloud
companies have two sources of revenue growth, one from redistributing the
existing IT expenditure pie to benefit themselves and one from organically
growing that pie by adding and improving services.
This is a powerful proposition, because once Cloud companies
have a proof of concept, showing that they provide services superior to
traditional methods, it should only be a matter of time for them to harvest
those traditional revenue streams, potentially on a global scale.
Figure 2. Cloud Revenues Growing at 16% Annually 
Source: HANetf; Gartner, April 2019; Statista, August 2019.
Another exciting fact that investors should take notice of,
is the upward revision for Cloud revenue estimates over recent years, which is
shown in figure 3. Often, analysts’ predictions of growth rates for new
technologies and industries can be overly upbeat and actual numbers tend to
underperform estimates, leading to somewhat weaker performance for the
underlying companies than originally predicted. However, the Cloud seems to be
an exception in this regard. Comparing revenue estimates in 2017 and 2019 made
by Gartner, a leading research and advisory company in the technology space, we
can see that within the space of only two years estimates have increased by
$40-50bn per year, a big relative jump. These types of unexpected upward
revisions tend to be catalysts for strong equity performance, as buyside
analysts and investors upgrade their equity valuation models based on those
improved earnings predictions and then invest in those companies as they are
now deemed undervalued based on the new data.
Figure 3. Cloud Revenues Estimates Experiencing Upward Revision
Source: HANetf; Gartner February 2017 & April 2019.
Has a Cloud ETF Investment Paid off so Far?
Fundamentally we have showed that the sector looks robust,
but has this also been reflected in stock prices of the underlying companies?
The short answer is, yes. A more detailed analysis can be found in figure 4.
which shows a table comparing the performance of the cloud sector against a
range of equity market indices. The Cloud sector is represented by an index which
has been in existence since 2011, so it represents actual live data and not a
back-test. We can see that on a cumulative five-year basis it clearly
outperforms the broader technology market, represented by the Nasdaq 100, as
well as the broader US and world equity markets, represented by the S&P 500
as we as the MSCI World. If we return to our initial question whether US
investors made the right decision by investing in this sector over the past
three years, we can conclude that indeed it was a good choice.
Figure 4. Equity Market Returns for the Cloud Sector
| 1-year time periods, starting 4th October |
Cloud Index |
Nasdaq 100 |
S&P 500 Index |
MSCI World Index |
| 2014/15 |
7% |
7% |
1% |
-2% |
| 2015/16 |
17% |
13% |
9% |
5% |
| 2016/17 |
24% |
24% |
18% |
17% |
| 2017/18 |
28% |
22% |
13% |
7% |
| 2018/19 |
4% |
5% |
2% |
0% |
| Cumulative return |
108% |
93% |
50% |
29% |
Source: HANetf, Bloomberg, 04 October 2019.
It is difficult to predict whether the mentioned asset
growth in ETFs or the upward revisions in revenues will continue into the
future. Our analysis might be prone to the same overly upbeat expectations that
we cautioned against earlier. But having looked at both the fundamental
underlying megatrend that drives the expansion of the Cloud, as well as a range
of economic and financial metrics, and also taking into account the strong vote
of confidence from a large base of US investors, we believe that companies in
the Cloud sector are well positioned to deliver future growth that is both
significantly higher than the average economy, and also long lasting.
Article Date: 13th November 2019.