The Cloud is the collection of servers, switches and databases primarily provided by Amazon, Google and Microsoft that allow companies to access computing, communication and storage resources as easily as turning on a tap. It reduces both the capital costs and engineering that would otherwise be needed to build a new business. This infrastructure is available at price levels that are low and keep dropping, even as the quality and security keep getting better. This infrastructure allows companies with great new business models to grow and scale at very high sustained rates, and bad ones to fail very quickly.
Many established businesses are migrating to the cloud. These include software companies offering their software as a service, information businesses that can serve their customers more easily from the Cloud. Some of these businesses support the cloud itself (like Amazon and Google) and those offering services like security and connectivity to operate the Cloud more efficiently and safely. Many businesses have started up that could only work in the cloud, like content streaming and social media companies. We believe that in almost every case that a traditional business is modernizing, there will be a strong cloud component involved. We also believe strongly there will be few businesses able to survive without well defined Cloud strategies.
Great new companies have historically required both capital and innovation. A new steel making technology for instance, might have required a steel mill to bring it to market. The same was true of communication and information-based businesses as they built the IT capacity to deliver their new products. The requirement to constantly fuel growth with significant additional capital has now been eliminated for many of the world’s most innovative companies. For many, their IPO is the last time they need to raise operating capital, and some have listed without raising any capital at all. Removing the capital constraint allows great ideas to flourish faster.
Consistent with other industries, large technology companies have strengths and weaknesses. They have large customer bases, established distribution and great brands. But they have a hard time disrupting themselves and they have a hard time retaining the people that create disruption and innovation. History shows that small companies tend to innovate, and large companies find it easier to buy them, applying those new business models and technologies to their existing customers and channels. Eventually the management teams that were acquired leave to create something new and the whole virtuous process starts anew. Extuple principals have lived this process first hand.
Hype runs ahead of reality. Although use of the Cloud has been growing since the early 2000s when companies like Salesforce started scaling the first CRM platform, the vast majority of computing and storage still resides in private corporate data centres. Many analysts think the Cloud now represents about 10-20% of computing, but those estimates vary widely. Along with its benefits, the Cloud brings its own challenges, like security, privacy and legacy application connectivity. We will see many more years of migration to the Cloud combined with the hyper growth of business models that could not have happened without it.
Some of us have backgrounds in cryptography and we like secure transaction protocols. And disrupting existing financial models seems really exciting. But we are skeptical about replacing highly efficient central counterparties using parallel scalability with disintermediated computationally intensive sequential peer to peer models. Maybe we will be proven wrong. But either way, we remain focused on allocating capital to well established business models producing rapidly growing positive gross margins! To date, we have not found any blockchain companies fitting that criteria.
Our research is completely focused on evaluating long term value, not predicting either short term results or non-financial events that could affect prices unpredictably. Instead of trying to pre-judge those events, we take advantage of them by reallocation within the portfolio. For even our favorite long term picks, it’s impossible to like them as much (all other things being equal) at twice the price.
We admit that originally it was the result of a few too many people who had taken a few too many math courses picking a name that their kids wouldn’t have to share. But its come to mainly be associated with our core valuation methodology. We use a proprietary valuation method to value companies that works as companies grow from significantly cash flow negative to wildly positive. The Xtuple, as its known inside our firm, is the multiple of gross recurring margin that takes into account various measures, such as the rate at which gross profits and overhead are growing and how quickly that growth is decaying. It’s the main valuation method we us to calculate our three-year price targets that we invest on. So that’s what the name is for (in hindsight).