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Cloud Computing Bubble Bursts Following Equinix (EQIX) Warning

By: John Darsie

It's been raining in New York City for the better part of the last week, but the Big Apple skies are not the only thing with heavy clouds these days. Cloud computing stocks have been all the rage this year, with everyone wanting a piece of the hot new technology that looks poised to be the next game changer in the tech space. Leading names like VMWare (NYSE:VMW) and Salesforce.com (NYSE:CRM) had surged 100+% coming into today, but recently had not been acting healthy. Many had started to grow skeptical of whether these cloud names could sustain lofty valuations and meet outlandish growth expectations. Well, today's debacle sheds some light on the subject.


 

While cloud stocks have been acting erratically for more than a week, a catalyst for momentum selling came after the close yesterday when Equinix (NASDAQ:EQIX) trimmed revenue outlooks and noted challenges moving forward in overcoming high churn and intensifying price pressures within the industry. UK listed company Autonomy (AU.L), an infrastructure software provider, added fuel to the fire with a warning this morning that revenue forecasts for the year were too high given that there is still high volatility in corporate IT spending. Fears about growth sustainibility in the highly competitive virtualization and data storage space have led investors to dump shares ahead of an important earnings season, which could produce additional damning evidence of a slowdown. We weren't without warning, though. Barron's published an article on September 11 questioning whether VMWare could continue to grow at the same clip given that at $85 dollars, it was trading at more than 60 times forward earnings. Even the slightest disappointment made VMWare vulnerable to a massive sell-off. The low hanging fruit in industry has been picked, and the landscape is growing much more 'cloudy' and competitive. Combined with a chilly macroeconomic climate, it is not wonder these companies have begun to openly express concerns about future revenue growth sustainability.


 

With the number of buyers chasing these stocks higher despite stratospheric valuations, it was a matter of time before the music stopped and the elevator dropped. It has been a tower of terror indeed for trapped longs. EQIX barely even adjusted revenue estimates down to $1.215 billion from $1.225-1.235 billion, and has fallen 33% as of 2pm Wednesday, dragging its colleagues down with it. The response to their report illustrates just how fragile the perch was for these cloud names. The bidding war for data storage firm 3Par also had increased the reckless bullishness in the sector.


 

Data storage stocks like Isilon (ISLN), Radware (NASDAQ:RDWR), Terradata (NYSE:TDC) and CommVault (NASDAQ:CVLT) are each down between 5-7%, but the big losers have been the more enterprise software focused stocks. Here is an abbreviated list of the carnage:


 

  • VMWare (VMW) down $8.20 or 9.63%
  • Salesforce.com (CRM) down $13.72 or 12.18%
  • Red Hat (NYSE:RHT) down $3.48 or 8.39%
  • Citrix (NASDAQ:CTXS) down $9.59 or 13.7%
  • SAVVIS, Inc. (NASDAQ:SVVS) down $2.33 or 10.76%
  • Rackspace Hosting (NYSE:RAX) down $3.16 or 12.06%
  • Akamai Technologies (NASDAQ:AKAM)  down $4.08 or 8.52%
  • and of course, Equinix (EQIX) down $33.29 or 31.73%

So, what now? With all cloud names now trading as much more realistic multiples, they become much more attractive investments from a value standpoint.  Downward momentum has seemed to slow for the time being, but from a strictly risk management standpoint it is hard to justify scooping up these stocks today and ahead of what now appears to be a make or break earnings season for the sector.  Let today's events serve as a powerful example of how investor greed, and ignoring valuations as Brandon wrote earlier today, can land you in a heap of trouble.