Amazon’s second act, Microsoft’s revival and red-hot IPOs highlighted the decade of the cloud – CNBC

Microsoft CEO Satya Nadella and Salesforce CEO Marc Benioff in 2014.

Source: Microsoft

The 2010s were the decade where companies got serious about moving everything to the cloud.

Dropbox and Slack became household names, Salesforce gained enterprise ubiquity, and Microsoft and Adobe revitalized their businesses by shifting from packaged software to cloud-based subscriptions, lifting their stock prices to record highs.

Formerly a side project, Amazon Web Services now generates $35 billion in annual revenue by allowing clients to offload their storage and computing needs to a third party, while ServiceNow, whose technology helps IT managers improve productivity, joined the S&P 500 last month after its market cap topped $50 billion.

In the past, companies, schools and government agencies operated their own data centers and bought expensive licenses to use software on their equipment, adding in hefty maintenance and update fees. The cloud changed all that, switching the applications that employees use every day as well as all the underlying databases, servers and communications equipment into services that can be delivered remotely to a host of devices over powerful networks. Customer service was upgraded, with a focus on user feedback, to keep clients from quitting their subscriptions and moving to rivals.

For investors, the paradigm shift presented an opportunity to put money into older companies positioned to make the transition, as well as a whole new crop of start-ups poised to take market share from the legacy providers. Slack, Twilio, Zoom and Okta were all founded in 2008 or later and are each now valued at over $10 billion on the public market. A bunch more are in the $5 billion range, and more still are filling up the IPO pipeline for 2020 and beyond.

Brad Gerstner, founder of Altimeter Capital, counts Salesforce as one of his top holdings and was a venture investor in Okta and Twilio. In a TV interview this month alongside Okta co-founder Frederic Kerrest, Gerstner told CNBC that the big bet has paid off.

"It really comes down to something that we talked about nearly a decade ago," said Gerstner, whose firm oversees more than $5 billion in assets, referring to his initial conversations with Okta. "We have a once in probably our lifetime rearchitecture of the entire enterprise stack into the cloud."

According to Synergy Research, 2019 revenue from enterprise software-as-a-service (SaaS) will exceed $100 billion, up from less than $4 billion in 2009. Adding up all layers of the stack, from the underlying infrastructure to the applications, IT service firm Gartner says cloud revenue will end the year at $214.3 billion, jumping to $331.2 billion by 2022.

In a $3.7 trillion global IT market with low single-digit expansion, annual cloud growth of greater than 15% is leading investors to bid up the cloud standouts in both the public and private markets.

If you're looking for the poster child of the cloud evolution, you may find it on the outskirts of Seattle.

In 2014, facing sluggish growth and disappointing investor returns, Microsoft turned to Satya Nadella to succeed Steve Ballmer as CEO, the first change at the top in 14 years. Nadella, who had previously run Microsoft's cloud and enterprise group, told employees on day one of his tenure, "Our job is to ensure that Microsoft thrives in a mobile and cloud-first world."

Weeks later Nadella announced that Office apps were coming to Apple iPads, giving customers more flexibility and showing that it was a new day at Microsoft. Office 365, the cloud version of Microsoft's flagship product, was launched in 2011, but the Apple integration was critical in bringing Word, Excel, PowerPoint and SharePoint to people who were choosing a competitor's hardware.

By 2017, commercial revenue for Office 365 had exceeded Office license revenue.

"I think the biggest event of the decade was Microsoft launching Office 365," said Todd McKinnon, CEO and co-founder of Okta who previously spent five years at Salesforce. "It was very clear that the largest software company in the world is saying, 'Cloud is good, Cloud will work, Cloud is sanctioned.' It changed the mindset of the IT industry."

Okta Conference hosts Facebook VP of Platform Partnerships Sean Ryan, Slack VP of Product April Underwood, Okta CEO Todd McKinnon, Box CEO Aaron Levie Zoom, and CEO Eric Yuan and moderator Brad Stone

Source: Harriet Taylor

McKinnon saw the movement firsthand. His company provides identity management software so businesses can securely control all of the cloud applications that employees are using.

"Companies of every size and every industry that we'd been having conversations with for years came back to us and said, 'This is real, this is happening, we need a real identity story,'" McKinnon said.

Meanwhile, Microsoft was also building Azure, its cloud infrastructure service that would eventually become the clear No. 2 to AWS, attracting as customers large retailers, health-care providers, banks and the U.S. Department of Defense along the way. Microsoft doesn't disclose Azure revenue, but it does report growth, which reached 59% in the third quarter.

Since the end of 2009, Microsoft's stock has jumped 417%, beating the S&P 500's 189% gain. This year it became the third company to reach a $1 trillion market capitalization.

Amazon isn't far behind at $889 billion, as of Monday's close. Much of Amazon's 1,233% stock surge over the last decade can be attributed to AWS, which in the latest quarter accounted for 71% of its parent company's operating income and 13% of revenue. Analysts at Jefferies said in a November report that AWS could be worth about 40% of the company's market cap, and the unit has gotten so big that it's now reportedly attracting antitrust scrutiny.

Salesforce, the company most synonymous with SaaS, has also taken advantage of investments made by the infrastructure players. In 2016, Salesforce said it would use AWS to expand its Sales Cloud and Service Cloud internationally and has since announced plans to use some services from Google and Microsoft's cloud.

While Salesforce is the biggest company that was born in the cloud, Adobe is the largest software maker to transition the majority of its business to the new model. Investors have rewarded the company, pushing the stock up ninefold since the beginning of the decade.

In 2009, subscriptions represented 3% of revenue. Two years later, Adobe introduced Creative Cloud, ushering in monthly and annual plans for access to apps like PhotoShop, along with cloud storage. Now, subscriptions account for about 90% of sales, and the company is growing at rates not seen since 1991.

"What we were able to do in terms of moving to this new way of delivering software was unshackle our product teams from the burdens of delivering products every 12 or 18 months and they could deliver at the pace at which they could innovate," CEO Shantanu Narayen said at Adobe's financial analyst meeting in November. "We were able to attract new customers to the platform, we were able to price these products globally differently."

Autodesk was founded in 1982, just like Adobe. It's undertaken a similar endeavor, moving its popular design and architecture software to the cloud. Carl Bass, Autodesk's CEO from 2006 to 2017, said in 2013 that the company "can get pretty close to subscriptions being the vast majority of our business."

He was proven right. In the most recent quarter, subscriptions accounted for 85% of sales, pushing total revenue up 28% from a year earlier. The stock has gained 620% since the end of 2009.

As Microsoft, Adobe and Autodesk were revamping their businesses, new venture-backed SaaS vendors were popping up by the month, unbundling the old software suites with targeted applications and solutions. The attrition rate has been high, but there are notable successes.

Videoconferencing company Zoom, which went public this year, reported revenue growth of 85% in the most recent quarter to $166.6 million. Twilio, a provider of communications infrastructure that went public in 2016, generated growth of 75% to $295.1 million in the third quarter. Newly public companies Elastic, Smartsheet and Coupa each reported growth in excess of 50%.

They're among the top performers in the BVP Nasdaq Emerging Cloud Index, a group of public companies that get most of their revenue from cloud products and services. Venture capital firm Bessemer Venture Partners launched the index in 2013 to bring more attention to cloud companies and provide metrics so private cloud companies could better understand public markets.

The index has risen 458% since it was formed, topping the Nasdaq's 146% jump over that stretch. In September, asset manager WisdomTree launched the WisdomTree Cloud Computing Fund, making it possible for people to bet on the group.

"We'd get tweets every week of, 'How can I trade this? How can I trade this?'" said Byron Deeter, who invests in cloud at Bessemer and sits on Twilio's board.

Rob Bernshteyn, CEO of Coupa, has been tracking cloud software since its infancy. While working at Siebel Systems in the early 2000s, he met Salesforce co-founder Marc Benioff and was skeptical of whether the company could provide cloud-based technology for many different purposes without extensive customization, even though Salesforce was already winning deals against Siebel.

"It wasn't really definitively clear to me that it could really work," Bernshteyn said in an interview at Coupa's Silicon Valley headquarters, where the server closets are filled with beanbags that employees use as chairs.

Over time, Bernshteyn said Salesforce fixed its technical issues. He considered joining the company but went to a younger cloud software provider called SuccessFactors, which was later acquired by SAP.

Bernshteyn left in 2009, in the middle of the financial crisis, and joined a small start-up that was helping companies track their spending to make sure they weren't being fleeced by vendors. That company, Coupa, is now worth over $9 billion and generating revenue of over $100 million a quarter.

But not all cloud stocks have delivered for investors.

Dropbox is 15% below its IPO price from 2018. Growth at the one-time venture darling has slowed amid competition from Google and Microsoft in the cloud storage and collaboration market.

Business intelligence software company Domo is up just 10% from its IPO in mid-2018 and way below where it was valued in the private markets before the offering. Yext, whose service helps businesses keep information like their addresses and hours up to date on Google and Amazon Alexa, is up 32% since its debut in 2017, underperforming the major indexes.

At 22% and 30% sales growth, respectively, Domo and Yext are expanding at a slower pace than many of their cloud counterparts, while still racking up big losses. It's a tough recipe for investors.

Yext CEO Howard Lerman is bullish on the broader sector. "Obviously at some point over the next decade, spending on cloud software will surpass licensed software," he said.

For venture investors, there's also plenty of money still to be made, assuming the public markets are on board. Deeter of Bessmer Ventures said there are 66 private cloud companies worth more than $1 billion.

"That's your future IPO pipeline," he said. "You're going to see this cloud index explode."

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