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The Race for Cloud Leadership or “Competing for the Future”

At the beginning of October last year, IBM revealed spin-off plans for a relevant part of its Services unit with the aim of re-entering the Cloud market. For some years now, the company has not had its efforts fully recognized by investors, as its Cloud division included different activities than competitors AWS, Microsoft, Oracle and Google.

The intention of the movement was to make cloud businesses more visible to the market, a first step that has already had a positive impact on stock market value. However, when isolating Cloud revenue we see that the company is very far from its rivals and, more importantly, its growth is still far below the dynamism demonstrated by Amazon and Microsoft.

Although IBM reported revenue of more than US$47 Billion in Services in 2019, analysts and investors have valued the “public cloud” or simply Cloud much more. In the chart above, we show IBM's position only in activities that the market values.

Even the acquisition of Red Hat for R$34 billion in 2018 was insufficient for stronger recognition by the capital market in this space: while the company's executives struggled to justify IBM as the third largest competitor in this space, the market saw Google in that position.

With this new restructuring, IBM positioned itself better by segregating businesses with such different dynamics and operations. However, your biggest challenge will be demonstrating growth capacity comparable to the best competitors.

But with a growth rate far from its competitors, even if IBM managed to grow much more - and for several years - it seems to us that this would make little difference to the market value: while IBM's market cap is approximately US$ 100 Billion , Amazon, Google and Microsoft show impressive US$ 1.6 Trillion, US$ 1 Trillion, US$ 1.58 Trillion with Oracle still well above IBM with US$ 177 Billion.

Much of the relevance of cloud business models for recurring revenues and market dominance is also related to confidence in the company's ability to incorporate the accelerated growth model and benefit from the tailwind of technological transformations.

The market is not just waiting for the migration to the cloud of companies and consumers who are only now arriving in the digital world, although the growth to be extracted from these latecomers is very significant. Much bigger transformations are coming with 5G, Virtual Reality, IOT and other trends that are expected to exponentially increase the consumption of services and technological infrastructure. These differences in market cap between the largest Cloud companies are also signs of investors' bets in the fight for a future that has already been ordered.

Therefore, from another perspective, when we compare IBM's value with recently listed companies that have built business models around needs not very well served by traditional companies, we see it far behind in dynamism when we compare its market value and growth. CAGR of recent years:

It is indisputable that the risk associated with IBM, a stable and well-managed company, does not compare to the risk that investors assume when betting on these new companies. It is also worth saying that in other segments, such as Artificial Intelligence and Quantum Computing, IBM has stood out. But it is surprising that companies with so little time on the market have become so valuable, coming to represent substantial portions of entire companies, much larger and with dominant positions for a long time.

Some important learnings emerge from this comparison:

(a) It is difficult to react to exponential trends when they materialize for the market, without having built, years before, capabilities, team and position, given the difference between IBM and AWS, Microsoft, Google and Oracle. And just as important as these elements is the attention and willingness of senior management to invest in the future, a skill that is difficult to cultivate in complex corporate environments;

(b) The market has rewarded growth disproportionately in relation to other considerations (such as risks) in the search for profitability in a global scenario of high liquidity and low interest rates: while IBM presents EV/Revenue multiples of 2.2x, Snowflake presents incredible 149x (data from 02/25/21);

(c) Business models built around incumbents' gaps, with a strict focus on very scalable offerings and very large addressable markets are disproportionately valued.

And analyzing what is happening in Brazil, we have two companies that have managed to transform themselves and are demonstrating that with a more dynamic and favorable capital market, it may not be too late to enter the competition for the future - Locaweb and Plusoft.

Locaweb, a publicly traded company with decades of experience, has built a position as a digital enabler, with a large addressable market, quickly gaining ground, and we can see (below, inserted in the previous graph) that it is closer to growth companies exponential than that of IBM with a market value of forty times its revenues:

Plusoft, a Brazilian private equity company with thirty years in the market and a national leader in customer experience solutions, carried out a bold transformation of its business model: from on-premises software to a cloud-based recurring revenue model, which places it as a a serious competitor to the largest multinationals in the sector. The examples of Locaweb and Plusoft show that relevant business model transformations are possible and highly rewarding.

Which Brazilian companies do you believe will dominate their markets and investors’ allocation in the coming years? A good clue was given by the District, which prepared a study on the next likely Brazilian unicorns.

At DealMaker, we are betting that this list will grow much more in the coming years with the help of mergers and acquisitions as a tool for capturing critical capabilities and accelerating growth.


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