The Cloud Market Gap

Aug. 7.12 | About: VMware, Inc. (VMW)

When reporters talk to vendors about cloud, they want to know about things such as Platform as a Service, or the coming replacement of network and storage hardware with commodity parts. When customers talk to vendors about cloud, they want to know about saving money in their data center or about trying out workloads on public clouds.

This "cloud market gap" can be confusing to investors, who mainly want to know where the money is being made, and maybe where the money will be made in the coming quarter. You can, say, follow the customers but customers are making plans based on image, so keep a wary eye on the reporters as well.

The companies this impacts most are the software vendors, VMware (NYSE:VMW) and RedHat (NYSE:RHT). VMware is the unquestioned leader in the market that exists -- virtualizing hardware so data centers become more efficient. RedHat has mostly been selling the market that will be -- widespread use of cloud infrastructure and platforms.

The gap, between what is and what will be, has caused the two companies' stocks to diverge. VMware is up 12% this year. But RedHat is up over 36%. This despite the fact that VMware is three times the size of RedHat (by revenue), with faster-growing revenues, and is bringing a bigger percentage of that revenue to the bottom line than RedHat.

For cloud investors, the lesson is that what will be trumps what is.

That may be why VMware recently put $1.26 billion into buying Nicira, an open-source project creating software-defined networks that can replace network hardware from companies like Cisco (NASDAQ:CSCO) and Juniper (NYSE:JNPR). VMware wants you to know that Nicira isn't just about replacing Cisco, but about "networking hypervisors" -- it is selling what will be.

Meanwhile, RedHat is hiring channels guys, trying to turn the potential of its open-source approach to cloud into sales in the here and now. It's also replacing some of its JBOSS middleware with a new product called Switchyard, which came from its FuseSource acquisition. The idea is to give existing customers a glide path from what is to what will be.

What does this mean in terms of revenues? Current cloud spending represents a $20 billion market. That's what is. But the latest "hockey stick" graph from consultants at Bain & Co. sees that growing to $150 billion by 2020 -- that is what will be. And even at that $150 billion figure, it's still just 8% of the technology marketplace.

That's why both of these companies sport such high price/earnings multiples. What is may look good, but what will be figures to be much better.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.