Among the megatrends driving the technology industry, cloud computing has been a force unto itself. For years, the cloud fattened Amazon, Microsoft and Google with high-profit service revenue and nourished growth at countless software and computer makers, and other tech firms.
XBut get out your umbrellas. The cloud has grown stormy, as third-quarter earnings details made all too clear.
Amazon Web Services fell short of the mark on both earnings and revenue, and reports say parent Amazon.com (AMZN) has frozen hiring at its cloud computing unit. The Azure cloud business at Microsoft (MSFT) posted an unexpected slowdown in cloud growth. As for Alphabet's (GOOGL) Google, the cloud business came in ahead of forecasts, but Oppenheimer analyst Tim Horan said in a note to clients that it has "no line of sight to meaningful profits."
As of now, these big-cap tech stocks still are growing their cloud business well into double-digit territory. But that may not last long given economic trends.
Many economists expect the U.S. economy to slow amid Federal Reserve rate hikes. The outlook for inflation is key.
The reports are critical because the three cloud titans have become a big sales channel for many software companies, while buoying the technology industry with enormous capital spending. This has benefited players ranging from semiconductor makers to internet companies.
"Cloud providers remain very bullish on long-term trends, but investors have been surprised at how economically sensitive the sector is," Oppenheimer's Horan said in his note. "Sales cycles in cloud services have elongated and customers are looking to cut cloud spending by becoming more efficient."
He added: "Despite the deceleration, cloud is now a $160 billion-plus industry. But investors will be concerned given this is our first real cloud recession, which makes forecasts difficult."
Long-Term View On Cloud Computing
In 2022, capital spending on internet data centers by the three big cloud computing stocks will jump a healthy 25% to $74 billion, estimates Dell'Oro Group.
But in 2023, spending on warehouse-size data centers packed with computer servers and data storage gear is expected to slow. Dell'Oro puts growth at just 7%, which would take the market up to $79 billion. That's bad news for semiconductor companies like Nvidia (NVDA), makers of networking gear and other companies in the cloud computing ecosystem. NVDA stock has tumbled 49% in 2022.
Some analysts still see a bright light at the end of the tunnel for tech stock giants Amazon, Microsoft and Google.
"This macro slowdown clearly will impact all aspects of tech spending over the next 12 to 18 months. Cloud spending is not immune to the dark macro backdrop as seen during earnings season over the past few weeks," Wedbush analyst Daniel Ives told Investor's Business Daily in an email.
"That said, we estimate 45% of workloads have moved to the cloud globally and (the share is) poised to hit 70% by 2025 in a massive $1 trillion shift. Enterprises will aggressively push to the cloud and we do not believe this near-term period takes that broader thesis off course," Ives said.
He added: "The near-term environment is more of a speed bump rather than a brick wall on the cloud transformation underway. Microsoft, Amazon, Google, IBM (IBM), and Oracle (ORCL) will be clear beneficiaries of this cloud shift over the coming years and will power through this Category 5 economic storm."
Best Days Over For Cloud Computing?
In other words, businesses still plan to shift their workloads to the cloud, but may brake somewhat in the near term.
As chief financial officers pore over tech budgets, pulling back from on-demand cloud services is a quick way to lower costs.
One reason for cloud computing's growth is that companies can dial up on-demand services as needed. That happened during the coronavirus pandemic. The flip side is that companies can turn off the spigot, too.
Companies may be pulling back on new projects as they tighten belts for a potential recession. But in the long run, they still have reasons to shift to the cloud.
Many are pursuing "digital transformation," a buzzword that describes a wide range of projects. With software, companies are automating business processes and converting paperwork into electronic records.
A financial services firm might overhaul how it registers new customers or collects sales data for analysis. A health care company could manage appointment scheduling or automate patient record-keeping. During the coronavirus pandemic, companies rushed to deploy customer-facing technology, such as chatbots on websites.
Next-Gen Cloud: Edge Computing
Bank of America expects a boost from next-generation cloud services that cater to "edge computing."
"Despite a slowdown, we continue to view the industry as attractive vs. other tech sectors," BofA analyst Justin Post said in a note.
Edge computing deploys data processing, storage and networking close to sensors. It's also where other data originate, near the "edge" of the network. It could be at a hospital, factory, transportation hub or a retail store. The goal is to process and analyze data locally in real time.
Amazon, Microsoft and Google are "treating the edge as an extension of their public cloud," said a BofA report. The giant cloud computing stocks have all partnered with telecom firms AT&T (T), Verizon (VZ) and T-Mobile US (TMUS).
The giant tech stocks aim to embed their cloud services within 5G wireless networks. "Telcos are leveraging the hyperscale cloud to launch their own edge compute businesses," BofA said. TMUS stock has climbed 29% in 2022.
At BMO Capital Markets, analyst Keith Bachman says investors need to reset their expectations as the coronavirus pandemic eases. The corporate switch to working from home spurred demand for cloud services. Online shopping boomed. And consumers turned to internet video and online gaming for entertainment.
"We think many organizations accelerated the journey to the cloud as Covid and hybrid work requirements exposed weaknesses in existing on-premise IT capabilities," Bachman said in a note. "While spend remains healthy in the cloud category, growth has decelerated for the past few quarters. We believe economic forces are at work as well as a slower pace of cloud migrations post-Covid."
Cloud Computing Market Forecast
Market research firm Gartner updated its global cloud computing growth forecast Oct. 31. The new forecast was completed before third-quarter earnings were released by Amazon, Microsoft and Google, said a Gartner spokesperson. AMZN stock has declined 48% in 2022.
Gartner predicted worldwide end-user spending on public cloud services will grow 20.7% in 2023 to $591.8 billion. That's up from 18.8% growth in 2022.
In a news release, Gartner analyst Sid Nag cautioned: "Organizations can only spend what they have. Cloud spending could decrease if overall IT budgets shrink, given that cloud continues to be the largest chunk of IT spend and proportionate budget growth."
It's called the "public" cloud market because the tech stocks rent servers and data storage. The cloud giants offer business customers processing power and data storage by the hour, week, month or year. Also, the cloud companies have been pushing new consumption-based services.
AWS, Microsoft's Azure and Google's cloud computing unit are all growing at an above-industry-average rate. Still, AWS and Microsoft's Azure are slowing, perhaps a bit due to size as well as the economy.
AMZN Stock: Third-Quarter Cloud Growth Slows
Third-quarter revenue at AWS came in at $20.5 billion. That's up 28% from a year earlier, but 2% below analyst estimates of $21 billion. Growth slowed from 33% in the June quarter and 37% in the March quarter.
AWS profit of $5.4 billion, up 11%, missed AMZN stock analyst estimates of $6.1 billion. Amazon pointed to wage inflation and higher energy costs.
"Amazon noted it has seen an uptick in AWS customers focused on controlling costs and is working to help customers cost-optimize," Amazon stock analyst Youssef Squali at Truist Securities said in a report. "The company is also seeing slower growth from certain industries (financial services, mortgage and crypto sectors)."
At Microsoft, "Intelligent Cloud" revenue rose 24% to $25.7 billion during the company's fiscal first quarter, including Azure's 35% growth to $14.4 billion. Excluding the impact of currency exchange rates, Azure revenue climbed 42%, missing estimates of MSFT stock analysts by 1% and slowing from June quarter growth of 46%.
Microsoft guided to "constant currency" growth of about 37% for the December quarter.
At Wolfe Research, MSFT stock analyst Alex Zukin said in his note: "The damage in Microsoft's case came from another Azure miss in the quarter, but the bigger surprise was the guide of 37%. That is the largest sequential growth deceleration on record."
MSFT stock has dropped 33% in 2022.
Google Cloud Beats Forecasts But Remains Unprofitable
Meanwhile, Google's cloud computing revenue rose 38% to $6.28 billion. That's up 2% from the previous quarter and topped estimates from GOOGL stock analysts by 4%.
But the company reported an operating loss of $644 million for the cloud business versus $699 million a year earlier.
Oppenheimer's Horan estimates that AWS will churn out $13.9 billion in free cash flow in 2022. But he sees Google's cloud unit having $10.6 billion in negative free cash flow. GOOGL stock has plunged nearly 40% in 2022.
Aiming to take share from bigger AWS and Microsoft's Azure, Google has priced cloud services aggressively, analysts say. It also stepped up hiring and spending on data centers. And it acquired cybersecurity firm Mandiant for $5.4 billion.
Tech Stocks And Long-Term Ambitions
At Deutsche Bank, analyst Brad Zelnick remains upbeat on the cloud computing business.
"We see a temporary slowdown in bringing new workloads to the cloud, though importantly not a change in organizations' long-term cloud ambitions," he said in a note. "The near-term forces of optimization can obscure what we believe remain very supportive underlying trends. We remain confident that we are in the early innings of a generational shift to cloud."
Some software growth companies now garner many new customers from the cloud computing platforms.
"Cloud consumption" software companies such as Snowflake (SNOW), Datadog (DDOG) and Confluent (CFLT) are among those that could be hurt if public cloud computing growth slows in the December quarter and into 2023, said a Morgan Stanley report. SNOW stock has retreated 62% in 2022, despite strong revenue growth.
DDOG stock rose on better-than-expected third quarter earnings.
In terms of exposure, RBC Capital pointed to Datadog as well as Fastly (FSLY), MongoDB (MDB) and Twilio (TWLO).
Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.
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