Picture this: you own a hotel on the outskirts of Glasgow that you built about five years ago. It’s a strange looking hotel; more like a corporate warehouse. But you offered a very special service at your hotel – one that has been in huge demand in the last few years.
In fact, your hotel has been almost fully occupied since it was built. And the business has been so successful that you soon set up outlets in Maidenhead, Manchester, Nottingham and London. Today, you serve 300,000 customers a day across Europe and you have reported a 970% jump in pre-tax profits since you turned profitable in 2010.
This is the story of ‘internet hotel’ group iomart. And the service it offers is cloud computing – one of the most lucrative investment stories of the last few years.
In fact, shares in Iomart are up five-fold in the last three years alone. And I think it’s worth saying that those are the kind of gains I expect from the cloud computing stocks I’ve been following in recent years.
The big lesson here is that by owning the technology that supports our economy, you could make serious gains on your investment. I’d like to tell you about another great cloud-computing stock I’m following today. But let’s start by talking about why these companies are in such huge demand.
A $146bn industry that just keeps growing
What are data centres? Well, these are large humming rooms of densely-packed computers that companies use to power their web servers and store vast quantities of information. Anyone who produces large quantities of data – from banks to telecoms – relies on these data centres to support their business, only they are very expensive to run. And so it’s dawned on executives that they no longer need to build and maintain their own computer hardware and software programs. They can simply rent out servers online or ‘in the cloud’ – just as a utility supplies electricity down the cable.
And it is an immensely profitable business. If you think of a data centre as a hotel with server racks rather than bedrooms, then iomart’s profits are driven by occupancy rates (how much of its server capacity it can rent) and room rates (how high a rent it can charge for using its hosting service). Not only are many data centres operating close to capacity, but they can also command very high rates. And this will continue as the volume of data we produce continues to escalate. Cisco forecasts that cloud data traffic will grow at 44% per annum during 2011-16, and that by the end of this period, nearly two thirds of all data centre traffic will be cloud based.
It’s an industry that is dominated by big companies such as Amazon – who have constructed vast server farms that are rented by businesses across the world. But although Amazon is the big player in cloud computing, it is not the only group that is profiting from this rapidly expanding industry.
In fact Gartner, the IT research specialist, estimates that the cloud computing market will become a $146bn industry by next year.
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Two great stocks worth watching
Iomart (IOM; 265p) was founded in 1998, but has narrowed its business focus over the last five years to concentrate on operating data centres (the hardware of the cloud) and providing hosting services (the software).
As is often the case in a rental business with high fixed-costs, underlying cash flow is strong and profits are operationally geared. In other words, as Iomart matures, cash and profit should build up rapidly. Last year, operating cash flow grew by over 50% to £14.8m! And although the shares are up five fold over the last three years, it has been a steady rise, without undue volatility. At 262p the shares sell on a price/earnings (p/e) of 26 times this year’s earnings, which are forecast to grow by almost 50% from last year’s 6.9p. Consensus earnings growth for the following year is for a slowdown to around 15%; but this looks too conservative.
Iomart provides the technology behind the cloud which enables companies like blur Group (BLUR; 318p) to provide their services entirely within the cloud. I can’t say I’m keen on blur’s pretentious lower-case name, but I’m prepared to overlook this given the exciting growth story.
blur is a good example of the much reduced costs emanating from cloud computing, allowing a company to start up without huge resources, yet provide a sophisticated service. Think of blur’s Global Services Exchange as an eBay for business. blur operates eight separate exchanges to match buyers and providers: design, marketing, content, art, innovation, technology, legal and Accounting.
Traditionally, a business needing to undertake a marketing project would automatically turn to their retained advertising agency for help. blur’s platform allows them to prepare a brief and invite pitches from 28,000 experts in 141 countries who are clustered on blur’s exchanges, rather than hope the one relationship they have with their ad agency comes up trumps. This is ‘expert crowd-sourcing’ in the jargon.
For the service provider it offers a big reduction in selling costs by streamlining the pitching process and putting them in front of new clients who might even be on a different continent. And it’s certainly profitable. blur takes a 20% commission on the project value. And like any exchange, it has increasing returns to scale. The more buyers and sellers, the more efficient the marketplace – the more likely it is that business will be successfully commissioned and that more projects will be offered.
The cloud and blur’s ability to automate the process using smart technology mean that the business should be scaleable into what is an enormous $1tn addressable s-commerce (social commerce) market.
The company raised £7.2m via a placing at 150p in May. This leaves the company with around £10m cash to live on until it becomes cash-flow positive. For what it is worth, Edison has blur making a small profit in 2015 followed by 13.7p of earnings per share (EPS) in 2016 which is a p/e of under 13 times.
To succeed fully, blur needs to get big quickly and become the destination exchange in the s-commerce space. If it does this, then profits will explode as critical mass is achieved. In this scenario, blur will be worth many, many times its current £78m valuation. This is one that is well worth watching.
• This article is taken from our free twice-weekly small-cap investment email, The Penny Sleuth. Sign up to The Penny Sleuth here.
Information in The Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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