Good question. The simple answer is “the cloud.” Amazon is the leading provider of cloud services, through its EC2 service. This provides an infrastructure that many companies depend on to solve complex problems, or quickly build scaled websites.
Clouds are important because they have immense capacity (any service can use the whole set-up when needed), because they're far more efficient than other enterprise set-ups, and because over time they mimic the dependability and robustness of the Internet itself. A cloud isn't just a data center. It's a structure under which you can run many data centers, sharing programs and functions as needed, breaking through capacity barriers without having to buy new hardware.
That said, what is cloud leadership worth? Is it worth 100 times earnings, as Amazon trades? Is it worth 92 times earnings, where Rackspace (NYSE:RAX) trades? How about 69 times earnings, which is where Red Hat (NYSE:RHT) trades? Or maybe 64 times earnings, which is where VMWare (NYSE:VMW) trades?
Fact is clouds have quickly gone from being interesting to obvious. They're where every vendor in the enterprise space is moving, just as fast as they can. They're what new IBM (NYSE:IBM) CEO Virginia Rometty is going to talk about ad nauseum over the next several months. They're where Dell (DELL) put $1 billion this year with plans to invest more. They're why Oracle (NYSE:ORCL) just bought RightNow (NASDAQ:RNOW) at a fat premium. Walk around the Microsoft (NASDAQ:MSFT) campus today, and you will see those working on Azure cloud technologies are the folks with the biggest smiles – the whole corporate strategy is aimed at the cloud.
Cloud technology is based on open-source software, which is visible to all. Anyone can download it, can run it, can even change it to suit themselves. Depending on the license they may or (more usually) may not have to share these changes – you can make money changing open-source code and selling the result.
This means that, while clouds are wonderful, their spread throughout the computing universe is going to be incredibly rapid. The premiums cloud software companies RHT and VMW trade at are unsustainable. The premiums cloud infrastructure companies RAX and AMZN trade at may, in the long run, prove equally unsustainable.
To buy these companies today, you must be betting that they will make breakthroughs that enable them to retain their leadership. You're playing hope. And hope is ephemeral, like a cloud.
Earnings are a better way to play. I'd short the cloud stack and go with the infrastructure plays for now. The spreads between them are bound to narrow over the coming months, and while the cloud players may emerge with solid victories and solid growth, they're all frothy at these levels. And I'd rather have coffee than foam, wouldn't you?
Disclosure: I am long IBM.