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Microsoft and AWS 'make up about half of the overall cloud software market': Analyst

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Brent Bracelin, Piper Sandler Equity Research Analyst, Cloud Software and Analytics, joins Yahoo Finance to discuss the outlook for cloud companies in 2022.

Video transcript

All right. Let's turn our attention to the Cloud. And we're going to bring in Brent Bracelin. Piper Sandler joining us right now. He's from Piper Sandler. Forgive me. The investment bank.

Just want to let people know. You've got more than 20 years in technology research. And this is your expertise how software applications and different software as a service firms can benefit.

Wanted to ask you. Are our company of the year is Microsoft? And they've made a big push with the cloud with Azure.

But there's a ton of companies in this space, smaller companies. In fact, one of the ones that has been part of the Piper Sandler family would be blend labs. Smaller, doesn't get a lot of attention. Not performing as well after they went public perhaps this year.

But what's the future for the smaller companies or will the Giants' like Microsoft's eat them up?

BRENT BRACELIN: Yeah, listen, I think we'll get to a point where we'll see consolidation in the Cloud software space. But for the time being, we really think we're in a secular growth pattern, where you're still going to see great opportunity that long tail of Cloud.

Today, Microsoft, we estimate will cross over $100 billion in their commercial cloud business in calendar '21. That is combined with AWS about half of the overall Cloud software market controlled by two platforms.

Think of Microsoft Cloud. Think of AWS Cloud as the cloud platforms. There's a lot of opportunity in the applications that sit on top and that are built on top of these Cloud platforms.

Snowflake very popular cloud data warehouse. That sits on top of those two cloud platforms. So I think there's plenty of opportunity as you think about an industry that is transitioned about 15% of the overall spend in the enterprise is shifted to Cloud.

We think it's a trillion transition. And so plenty of opportunity for Microsoft, plenty of opportunity for Adobe because these are the big cloud platforms. And then a lot of interesting niche specialized application can sit on top of those big cloud platforms and drive a lot of differentiation.

- Brent, this is Emily. I wanted to ask. You were talking about some of these winners the secular growth trend that we're seeing for some of these names. But what about some names that have been seeing some slowing growth trends?

And I'm thinking about DocuSign, of course, which disappointed on third quarter Billings. Are you seeing any other names that you could call out specifically that are perhaps not going to see the same type of growth that they saw during the pandemic?

- I think what's happening is something a little different. I think what we saw was a sharp acceleration pre-COVID to post-COVID, where we're seeing really strong adoption of these cloud technologies. Valuations reset. The peak valuation level for Cloud software names was about 14 times.

That became the new trough. 20 times revenue became the new peak for two years just in the last, I'd say two weeks. We've seen valuations go back below the trough of 14 times going back to pre-COVID levels.

So yes, you are seeing some of those tough compares and growth start to moderate. But I think more importantly, you're seeing just valuations rerating correct to levels that we saw kind of pre-COVID. So that's more of a valuation reset standpoint.

I think fundamentals across the broader Cloud group still remain strong. Recall Microsoft saw accelerating growth in their cloud business last quarter. So there are going to be certain company specific dynamics. But by and large, fundamentals for that cloud group look really strong.

- If I'm hearing you correctly. And a lot of people are listening. It sounds like opportunity for investors who want to find, you know, maybe something specific Cloud-related. But I'm thinking about the IBM Red Hat deal. And as it was explained to us. I think it was three years ago. And we met with people from the team who was explaining why it was beneficial.

They talked about the fact that you would not be beholden to one company, one cloud. That through Red Hat, you could go via IBM from cloud to cloud to cloud different integrations. Is that still a necessity? Or are there smaller companies that might beat IBM in that, or would I be better off just doing I'm with us, or I'm with Azure, and I stick with them?

- Yeah, listen, I think there's a lot of different ways to kind of create wealth in this space. I think the most important thing to acknowledge is the valuations were really high kind of post-COVID they're being reset. And just pick your spots.

There's some great opportunities we think multicloud. These applications like a Snowflake or a MongoDB that run on multiple clouds are certainly well positioned. But those stocks are priced at premiums.

And so there's a great opportunity to find some of these names that are 30%, 40%, 50% below the highs still have good fundamentals. And I think it's a good start, a good place to start looking for new cloud investments. But I think we're in a period of digestion.

These are multiples that we've had very, very high multiples on these Cloud software names for two years. We're one week into kind of a valuation rerating across the group.

And so I think we should give us some time. I think you should start to look at some of the fundamentals for 2022 and 2023. And I think that's really where I would try to focus some attention on.

But take time. You know, these valuations, we need to see kind of a floor when you see stabilization. But as we think about the next 5 to 10 years, 15% cloud penetration. We think it's going to over 50%.

So lots of opportunity here in this space still. But just be careful on valuations.

- All right. Brent Bracelin from Piper Sandler. We appreciate the advice.

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