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Apple and Microsoft’s Cloud Puzzles Are Missing an Acquisition

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July 27, 2014 – Comments (0) | RELATED TICKERS: AAPL , MSFT , GOOG

Apple, the glorious king of the digital world in the 21st century, has been losing its competitive advantages quickly to nasty competitors such as Samsung since its visionary founder, Steve Jobs, passed away. Critics say that the company has lost innovative savvy and poise, evidenced by the absence of major innovations since the inception of the iPhone and iPad. I am not sure if Apple is really losing it edge in making mobile devices, but I think the more serious problem for the company is that so far it has almost completely ignored cloud computing, dubbed by most tech gurus as the “next big thing” of the digital world in this century. By not paying sufficient attention to cloud computing, Apple is in danger of making a mistake similar to the one Microsoft made in the late 90s of not paying attention to mobile computing. The underlying cause of Apple’s reluctance to embrace cloud computing lies in its deep roots in hardware, similar to Microsoft’s deep roots in desktops and servers. VC Fred Wilson explained Apple’s problem in an interview during Tech Crunch’s last Disrupt conference.

 

Now, suppose Tim Cook listens to Fred and decides to steer Apple toward cloud computing with full throttle. How can he do it? It is a daunting task because the tech giant has fallen behind its major competitors¾Google, IBM, SAP, VMWare, etc.¾by miles in this race. As innovative and creative as Apple’s computer engineers are, it will not be easy for them to make major breakthroughs in internal development of cloud technologies and products because cloud solutions are so different from traditional hardware apps. Sometimes you really can’t teach an old dog new tricks. Microsoft has provided a great example of this adage for us. So, what’s the solution? Well, maybe it again lies in the old wisdom (Bill Gate’s famous quote): “if you cannot beat them, buy them!” If it is hard for Apple to develop the technologies internally, why couldn’t it buy a cloud computing company to immediately obtain top-notch cloud technologies/products and merge them with Apple’s existing solutions?

 

One look at the applications of this strategy by Apple’s major competitors, who have gained significant progresses in cloud computing over the past decade, should convince Mr. Cook of the effectiveness of this expansion-by-acquisition strategy. Here is a list of IBM, Google, and VMWare’s cloud-related acquisitions over the past five years:

 

VMWare: 26 cloud computing-related acquisitions.

 

IBM: 6 cloud computing-related acquisitions (Cast Iron Systems, DemandTec, Green Hat, Urban Code, SoftLayer Technologies, and Cloudant).

 

Google: 2 Cloud computing-related acquisitions (Talaria Technologies and StackDriver).

 

Many other cloud computing-related M&A deals are made almost every month, and mega deals ($1 billion+ price tag) are not uncommon. CloudCow.com and TalkinCloud.com show most of the deals that happen in the industry. So, it is almost common sense in the computer industry that acquiring or merging with another company is the quickest way to advance a company’s cloud technologies, solutions, and product offerings.

 

Even Apple’s long-time antagonist, Microsoft, made a deal in cloud computing by acquiring GreenButton last month to advance its cloud offerings.

 

Like Apple, Microsoft (MSFT) was also late to cloud computing and resisted fully embracing cloud computing until recently. Over the past few years, Microsoft has devoted a lot of capital and resources to strengthen and expand its cloud computing efforts and try to catch up with the pioneers and dominant players of the industry. In spite of moderate success, Microsoft still lags behind its major competitors in public and private cloud offerings. Its cloud offerings just broke $1 billion in revenue run rate last year. Based on its last 10-Q filing (Q3 FY2014), its Assure revenue grew by 150% and Office 365 revenue grew by more than 100% compared to the same period last year. Therefore, it can be estimated that Microsoft’s current total cloud-related (public and private cloud offerings) annual revenue run rate is between $2 and $2.5 billion. Now those numbers seem impressive at first glance, but the software giant still has a long way to go in the cloud industry. Amazon, Microsoft’s biggest rival in the public cloud, is generating about $1 billion quarterly, or $4 billion annually, from its public cloud offering Amazon Web Services (my own estimation based on the $850 million AWS quarterly revenue run rate Amazon announced in Q3 2014 and “other revenue” reported in Amazon’s last 10-Q report). VMWare and Citrix, two leading pure-play cloud companies, are churning in about $5 billion and $3 billion a year respectively.

 

In other words, whatever acquisition strategies that apply to Microsoft probably apply to Apple as well because they both desperately need to catch up with their major rivals in cloud computing. So, what are good acquisition targets in cloud computing for Apple to consider? Here are two choices that come to the top of my mind:

 

The Big: VMWare (Nasdaq: VMW)

 

This one may seem to be too big and out of reach, but why not? VMWare is the pioneer of cloud computing and still owns some of the most advanced and robust products and solutions in the industry. It is the leader of the industry in terms of market share and certainly is the biggest pure-play cloud computing company. If Apple acquires VMWare, it can recover all the years it has lost in the cloud race and jump on top of the score board overnight! Just the marketing catch-phrases of “VMWare inside” and “Apple on Cloud” will be enough to make Apple’s fans scream and competitors sweat!

 

Because VMWare has spent years building support for MAC in its Fusion solution suite and developing iTunes apps for its Horizon, vSphere, and Mobile Knowledge Portal products, Apple’s development team may find it easier to integrate VMWare’s cloud systems than to integrate other cloud systems with Apple’s own systems.

 

It all sounds great, but what’s the catch? Well, the price tag surely will be high¾very high. VMWare’s current market capital is about $41 billion. To get a nod from VMWare’s board of directors, Apple probably needs to put at least $55 billion in its buyout offer, representing a little over 30% premium for VMWare’s shareholders (my personal gut feeling, only based on the premiums of some buyout offers for companies of similar size). Will the acquisition be worth the money for Apple? Let’s see. VMWare earned around $5.2 billion revenue last year, and analysts are estimating $6 billion in revenue for the company this year. If Apple pushed VMWare’s products through its immense global distribution network and customer base, it might not be difficult for Apple to double the sales of VMWare’s products to $12 billion per year. In addition, by putting strong cloud computing functions into its Mac desktops, laptops, iPhones, and iPads, Apple may be able to take some market shares from Microsoft and Google. If Apple can expand the annual revenue of its existing products by just 10% by integrating VMWare’s products with its own, it will reap $17 billion in additional revenue from the acquisition. If these two goals are accomplished, Apple will gain $29 billion in incremental revenue and potentially a couple billion dollars’ worth of cost cutting on VMWare’s SG&A costs. The return on the $55 billion investment then will look pretty decent!

 

In addition to the tangible hard-dollar returns, by absorbing VMWare Apple would be assured of maintaining its status as the leading technology innovator in the digital world for many years and not have to worry about falling out of favor quickly like Nokia and Blackberry did.

 

The Small: Sphere 3D (OTC Symbol: SPIHF, Toronto Stock Exchange Symbol: ANY)

 

If Apple does not feel comfortable spending such a huge sum in its first attempt at cloud computing acquisition, a small company called Sphere 3D might be a good target on the other side of the scale. For the past year or so, this fast-rising new star has arguably been the hottest hit in cloud computing. The company invented and owns a unique technology called “Microvisor” that was dubbed by some analysts as the most disruptive innovation in cloud computing ever! According to the company’s own website and its executives’ words in interviews by MidasLetter and Brian Madden, the company’s centerpiece product, Glassware, makes legacy desktop-based applications such as AutoCAD, Photoshop, Corel Office, medical applications, etc. cloud-ready and accessible from client devices running on any operating systems and hardware. More amazingly, its cloud solution is said to be much more “lightweight” than its major competitors, allowing its enterprise clients to deploy legacy applications to the cloud in an almost drag-and-drop, plug-n-play way without lengthy and cumbersome setups and configurations. With such powerful technology, the company has acquired endorsements from three highly-reputed analysts groups and signed cooperation agreements and/or commercial contracts with technology powerhouses and big organizations, including Apple, Corel, VMWare, UniPrint, Dell, Novarad, Ericsson, and CCPS (for a large quantity of Google Chrome Book cloud services).

 

The benefits for Apple, if it were to acquire Sphere 3D, are that the nature of its Microvisor technology (any application, any platform) should make the integration of its cloud solutions with Apple’s products easy and that it is already “Apple-friendly” with its Corel Office and Surf to Go for iPad. In addition, although it is small, Sphere 3D still offers a complete product line of cloud solutions – Glassware for enterprise cloud, Surf to Go for individual consumers, a V3 solutions suite for desktop virtualization, and Overland product lines for cloud storage and data protection (assuming that its acquisition of Overland is completed as announced).

 

Now, how much does Apple have to offer to get a nod from Sphere 3D’s board of directors? Well, it is really hard to estimate because it is such a young company; no one even knows if its founders are willing to sell the company anytime soon. Assuming that they are, my “wild guess” for the price tag is $1-$2 billion. Would the company be worth that much for Apple? I think it probably would. Assuming that Apple can push the sales of Sphere 3D’s products to just $2 billion through its distribution channels and huge customer base and expand the annual sales of Apple’s existing products by just 3%, or about $5 billion, by adding cloud functions/capabilities to its products, Apple will reap $7 billion in incremental annual revenue from an investment of $2 billion or less!

 

The Rest: There are simply too many other candidates of cloud computing for Apple to consider (again, just look at the number of M&A deals happening in the industry every month). For example, if size is critical and Apple thinks VMWare is too big while Sphere 3D is too small, Citrix might be the answer in the middle of the scale (however, I believe Apple may run into the risk of still paying a lot while not getting either dominant leadership status or top-notch new technologies with an acquisition of Citrix). One thing is certain: if Mr. Cook does decide to buy one of the good cloud computing companies, he had better do it sooner than later because their prices are ballooning; VMWare’s stock price increased by over 50% and Sphere 3D saw its stock price multiplied by almost 20 times over the past 12 months. More importantly, good assets are sold out quickly as time goes by; Apple’s cash-rich competitors Microsoft, Google, and IBM could decide to make a move on VMWare any time. As for Sphere 3D, even more competitors could decide to swallow Sphere 3D in a swift acquisition as its publicity and visibility are expected to increase drastically after it completes up-listing to NASDAQ.

 

Oh, by the way, Mr. Cook should be prepared for a bidding war on any good target because his opponents may not make it easy for him to eat into their market share in cloud computing.

 

For investors who want to gain from the industry’s M&A fever, history teaches us that it is very difficult to predict the timing of an acquisition or merger. In many cases, such as IBM’s buyout offer for Softlayer and VMWare’s acquisition of AirWatch, most people did not have any clue about these buyout offers in the making when they were being negotiated. Then when a deal was announced, a lot of people were shocked, regretted not owning any shares of the buyout target, and couldn’t stop mourning the lost opportunity. On the other hand, it is also advisable NOT TO base a decision of whether to invest in a stock solely on its potential of being bought for a premium, because no matter how appealing a company looks like to potential suitors, a deal may never happen for one reason or another. So, buy a high-tech company because you like its technologies and products and believe it has a bright future. If it is bought for a huge premium, great! You get a bonus. If it never happens, so be it.

 

Disclaimer:

 

This article is not an investment recommendation. This article reflects the author’s personal views only. The author does not receive any compensation from the companies mentioned in this article or their related parties. Please do your own due diligence before investing in any stocks mentioned in my article. All data and calculations presented are accurate to the best of the author’s knowledge but have not been vetted, checked, proofread, or independently verified.

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