Trust – the new industry

Every couple of days, Kiminari Suzuki shows up with all his bags on a stranger’s doorstep in a new part of the world, and then stays the night.

Kimani’s house in Japan was destroyed in the earthquake in 2011 you see, and ever since, he’s travelled the world staying with strangers using the website Airbnb. Airbnb helps people host travellers in their unused apartments and spare rooms, like an amateur-run hotel. Travellers get cheap quirky accommodation, and hosts get cash. It’s a great service.

The genius of Airbnb is that it’s created an online community. Hosts and travellers have to be very careful to maintain their reputation if they want to keep using the site. It’s all about trust. Airbnb is one example among many of technology bringing strangers together, and helping build trust between them.

Want an apartment? Airbnb will sort you out. A lift to the airport? Lyft can help with that. Advice on your outfit? You can hire a stylist for an hour on Google Helpouts. With the internet, people who don’t know each other can help each other out.

Now, that’s all well and good if you want to rent a loft in Barcelona for the weekend. But can a real business work like this?

Renting an IT department

For obvious reasons, IT departments have taken the lead with this stuff. Take cloud computing for example.  Moving IT functions into the cloud is a big step. The cloud provider becomes responsible for renting the software you need to operate.   But it also owns the hardware on which customer data and business records are stored. Again, it comes back to trust.

The technology to do it is here, and it’s getting cheaper all the time. The next step is building trust in the strangers at the other end of the fibre-optic cable.

If you can get past this, the cloud has many advantages. It’s cheaper for one. “Software as a service” is delivered over the internet, you pay a rental fee each time you use it. For companies, this means less upfront investment in software and steadier costs.

You don’t own the machines the software runs on either. They sit in big datacentres, looked after by someone else. Again, you don’t suffer the big initial cost of investing in hardware.  As with all outsourcing deals, your business benefits from the external provider’s expertise and economies of scale.

The software providers might make less from this in the short term, but it leads to better more reliable income in the long term.

Will Telecity profit?

Like its cousins, the consumer peer-to-peer sites, the ‘cloud’ industry has grown strongly in recent years. Datacentre shares such as Telecity (TCY: LN) have produced some outstanding returns. Telecity began 2012 with its shares at 630p and saw them rise to over 1,000p by this summer. However, they have fallen back sharply since. They’re back to the levels of early last year despite demand for cloud hosting of applications continuing to grow. So what’s going on?

It looks like two things are happening. The first is basic supply and demand.  Strong demand led to a lot of investment in datacentre capacity. Last year saw a particularly large increase in space and it seems that this has had an effect on prices.  That might just be a blip. Market conditions might return to a better balance, because less capacity has been added in 2013. That’s what happened around the turn of the millennium, when huge resources were ploughed into undersea data cables. At first there was a supply glut, but demand soon grew to fill it.

The other thing that is causing the market to worry is a possible change in the industry. The likes of Amazon, Microsoft and Google have moved into cloud service provision.  Of course they may be customers of datacentre companies like Telecity… but they could compete with them too.

When the market develops doubts about a growth stock, the impact on the share price is usually magnified. A small drop in profit forecasts is often combined with a much bigger fall in the price/earnings (p/e) ratio. So back in July, one broker was forecasting earnings per share of 43.8p for Telecity in 2014, which gave a p/e ratio of 22.5. That earnings forecast has only fallen by 5% to 41.7p, but the shares have dropped by a massive 33% to 661p. The p/e today therefore stands at 15.9 times, which is a much more modest premium to the market average.

I’m sure the trend of renting rather than owning is here to stay, and that outsourcing will continue to grow strongly. The big question for Telecity and other datacentre operators is whether that growth will deliver the sort of returns it has in the past.

This article is taken from our FREE penny share investment email Penny Sleuth.
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