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Cloud Computing - Valuations Today

|Includes: CRM, Equinix, Inc. (EQIX), GOOG, RAX, TMRK

A couple days ago, I wrote a piece on the long term secular merits of cloud computing. Today, I'm writing about valuations. Every stock has its price to buy AND sell.

I highlighted 5 names that currently do, or will benefit from continued growth in cloud computing. Here they are.

  1. Rackspace (NYSE:RAX)
  2. Terremark Worldwide (NASDAQ:TMRK)
  3. Google (NASDAQ:GOOG)
  4. (NYSE:CRM)
  5. Equinix Inc. (NASDAQ:EQIX)
I wrote in the last piece that with a 20% long term growth rate, one could expect to pay up for future earnings at about 30-40x forward (next year) earnings. We should also remember that there is likely to be a lot of consolidation in next few years and the landscape to become quite competitive. The BIG winner in terms of stocks, might not even be traded or even exist today. Perhaps they exist only in a University dorm room today!

Now to valuations. (Source: Yahoo Finance)

Rackspace (RAX) FY 2010 Estimates
  • Earnings 0.37
  • Revenues 754.30M
  • Growth 22.12%

Rackspace is probably the most "pure play" of all the cloud computing stocks. For this reason, I also believe it deserves a premium. It's small size makes it a nice acquisition, at the right price. If I use a 2x growth PE on forward earnings of 0.37, I come up with a $16.37 stock. The stock currently trades at $21.95 as I write this. That implies an approximate 60 forward PE.

Terremark Worldwide (TMRK) (FY 2011)

  • Earnings -0.03
  • Revenues 348.70M
  • Growth 22.5%

Terremark can't be valued the same way as even its FY 2011 earnings estimates are negative. However, it does have revenues of 348.7. This is about half that of Rackspace. Let's assume for the moment that margins remain inline with Rackspace. This would put the value of the company at about $7.56. (348.7/754.3 x 16.37) Alternatively, If I price it using the market value of Rackspace trading at $21.95, it yields $10.15. As I write this, it is trading at $8.20.

Google (GOOG)

  • Earnings 26.47
  • Revenues 20.49B
  • Growth 21.34%

Google obtains very little of its revenues from its cloud computing services, however, I think that is one of its significant sources of long term growth. I'll apply the same valuation method here, knowing that it still would not be an apples to apples comparison with these other firms. With forward earnings of $26.47, a 21.34% growth rate (I find this a bit suspect as I don't think it can maintain this rate on a base revenue of over $20B), and a PE premium of 1.5x growth, this yields $847. However, I think one has to consider the prospects of Google pulling out of China as a serious long term impact to growth and thus, I feel its reasonable to reduce its long term growth by 5%. This is somewhat of an arbitrary number, as is the PE premium, so feel free to use what you like in your own comparisons. This new valuation yields $649. The stock is currently trading at $587. (CRM)

  • Earnings 0.83
  • Revenues 1.50B
  • Growth 37.5% is probably the best implementation of a cloud computing business model to day. It clearly deserves a premium, but let's see how far that takes the valuation. Earnings of 0.83 with a whopping 37.5% growth rate. I'm not sure how much I buy that as a long term growth rate (5 year run rate), but lets assume it to be true for the moment. Thus, applying earnings of 0.83 x 37.5 x 2, yields $62.25. The stock currently trades at $69.03.

Equinix Inc. (EQIX)

  • Earnings 2.08
  • Revenues 1.08B
  • Growth 17.82%

And finally, we have Equinix which is the most hardware driven of the cloud computing stocks. I also think this is going to be a VERY competitive area within the cloud computing space as large players such as IBM, DELL and others, enter and compete in the space. Earnings of $2.08 with a growth at 17.82% and a PE growth premium of 1.5 yields $55.59. The stock currently trades at $102.

In summary:

  • RAX: valuation $16.37, market price $21.95 -> 34% premium
  • TMRK: valuation $7.56, market price $8.20 -> 8% premium
  • TMRK: alternative valuation $10.15, market price $8.20 -> 19% discount
  • GOOG: valuation $649, market price $587 -> 10% discount
  • CRM: valuation $62.25, market price $69.03 -> 11% premium
  • EQIX: valuation $55.59, market price $102 -> 85% premium

As we can see, the two stocks that trade at a discount to this valuation are the two with noticeable risks. TMRK currently has negative earnings and GOOG has the impact of withdrawing from China to contend with as well as it's shear size. It is much more difficult to maintain a 21% growth rate for a $20B revenue company that it is for $750M. Personally, I find the long term growth estimate for Google as suspect.

CRM, I find to be fully valued at the current price. EQIX, I actually find overvalued. While not a reason in itself to short, it is a reason for me not to buy this particular stock even with the secular winds to my back. Finally, this leaves RAX, which I think is an excellent pure play, has positive earnings, its long term growth rate is most sustainable and services the software side as much as the hardware. It does trade at a bit if a premium to valuation but less so relative to its peers in this group. RAX is one of those names I want to accumulate on a pullback.

Disclosure: No positions