Many people are talking about the “Cloud” – the ecosystem of servers and related technology that enables remote data processing and storage. What I don’t hear is why this represents such a significant shift in how tech companies are valued and how the economy will change as a result. I have always found that taking a longer perspective is more helpful, so let’s start there.

The current tech wave is centered around the development of the microprocessor, and how it affects telecommunications. In 1971 Intel invented the first microprocessor chip while building a chip solution for a calculator contract they had won. Quickly, other companies followed suit and constructed their own microprocessors. The race was on for the applications that followed.

Apple released its first computer – the Apple 1 – in 1976 and IBM released the PC in 1981. Those two personal computers would come to totally dominate the industry in the same way Ford and General Motors did at the commencement of the prior tech wave at the start of the 20^th century.

What few remember today was that computing, either for business or personal use, was really a solitary event. The mainframes back in the 1970s had terminals attached to them, but they spoke only to the computer to which they were attached. Terminals often weighed in excess of 100 pounds and could only communicate with the mainframe they were attached to, even though hundreds of them could be attached to the same mainframe. They were primarily used for invoicing and other mundane business chores.

PCs and Apples were similar in that users were working by themselves on games, spreadsheets and word processor applications. It took years for PC system architectures to become increasingly stable. My roommate in college was an engineer who bought an early Apple and complained bitterly to me that it was only accurate to a few decimal places. In other words, calculators were more accurate than the early PCs.

As the applications progressed, more features were added. Modems could be attached to PCs by the 1980s. These modems were used to connect message boards where messages could be swapped and software downloaded.  Future ISP giant AOL began as a small message board company at that time.

It was not until the mid-1990s that PCs began to interact regularly with other users and companies. Of course, at that time the driver was the Internet, and more specifically the creation of the first widely adopted Mozilla browser by Marc Andreessen. Until that time we had to use what was called emulator software, which turned your PC into a relatively dumb terminal. The first time I connected to a government law library I was thrilled at the ability, but the Internet was not of much use until Andreessen released what would become the Netscape browser.

Just as Henry Ford thought he would only need to build inexpensive Model T’s, Bill Gates’ first comment about the Internet was that it would never amount to anything useful as he couldn’t see how to make money with it – at first. Of course, this quickly changed and Microsoft would do an about-face within a year and build a competitive browser to Netscape, as they saw the Internet as a threat to their operating system revenues.

The cultural heritage at Microsoft is the reason why Microsoft very quickly fell behind in the build-out of communication properties for PCs, and why they fell behind Apple so badly by 2010. Of course, Microsoft had taken so much market share from Apple that Apple had little to lose by completely embracing an always-connected world. This is why Microsoft surged ahead in the latter 1990s, and then fell behind Apple a few years later.

Interestingly, it was Marc Andreessen who began to proselytize about the Cloud. The reason Andreessen began focusing on the Cloud so early was that Microsoft had bankrupted his Netscape business when Microsoft gave away their browser as a standard feature in their Windows operating system.

No one knew it yet, but that was the peak of Microsoft’s market value. They even went so far as to give Apple $150 million in orders to make it appear that they were not an operating system monopoly, in response to the antitrust cases that would be filed by the U.S. and European governments starting in 1998.

The backdrop to the antitrust drama was the dotcom collapse that began in 2000. Too many investors had invested in dotcom sites, and as their utility was proven to be thin at best the market began its contraction. That contraction – which appeared primarily as a business recession from 2000 to 2003 – would culminate with the equity bubble being pushed into real estate and the subsequent stock market crash in late 2008.

As a result of the Great Recession, every business in every industry began to seriously reconsider what they were spending on their internal technology systems supporting their business. Managers saw the Cloud as the primary technology that could radically reduce corporate tech spending.

What is the Cloud?

In order to understand why the Cloud will have this impact we should really talk about what Clouds are. Most people have heard about Apple selling iTunes and the end users’ ability to store their music on Apple’s Cloud. This is, however, the least valuable Cloud example that leads to misunderstanding and to wondering what the big deal is about Clouds as a result.

The two most important factors that Clouds are built upon are virtualization and what is referred to as auto provisioning. Allow me to explain what these are and then why these developments are creating a complete remodeling of computing in the 21^st century.

Virtualization – This is a technology that existed on IBM mainframes for years starting in the early 1970s. However, it had not existed on PC servers, which are called x86 servers in the tech industry, prior to the latter 1990s. VMware’s x86 virtualization product would be an answer to a problem which had plagued x86 servers since PCs had begun being used as servers.

PCs used as servers had a stability issue. Businesses could use only little more than half of the processing power for x86 servers because they would crash when their utilization would exceed 50 percent. As a result, most businesses were forced to buy more x86 servers than they needed, along with more copies of server operating system and applications than necessary.

Underutilized assets were understood as the cost of using x86 servers, which are cheaper to purchase than proprietary UNIX and mainframe servers. The tipping point for Clouds occurred in wake of the Great Recession. Business executives cut budgets, which forced IT departments to adopt virtualization technologies to reduce their cooling costs by reducing the number of x86 servers running on data center floors.

What virtualization does is cut up the server’s physical resources to make one server appear as 100 or more logical (represented) servers, or many servers to appear as a single very large server. As companies virtualized their x86 servers they either knowingly or unwittingly made the first crucial step towards moving into the Cloud.

Automated provisioning – The second step towards a functioning Cloud is the automated provisioning of resources that businesses need to respond to systems requirements from their operating units. Previously, it could take months to test and deploy the hardware and software required to provision the resources required for customer and operating units. Again, this was an accepted practice when staffs and budgets were larger. With auto provisioning fewer resources are needed.

What we have described in x86 virtualization and auto provisioning so far is why Clouds have hit their tipping point in the marketplace today. Now, let’s discuss why Clouds will change the computing world over the next two decades just as dramatically as the confluence of automobile production and the national highway system did in the 1940s through the 1950s.

Reducing costs for business is always important, but in conjunction with the added speed which Cloud Computing brings it is a real game changer. The reason why is predicated in what will be the response from these technological architectures.

Lightweight mobile devices such as smartphones and tablets will not be required to have the local storage or processing power that PCs have today. This will enable customers and businesses to quickly and easily do almost everything done on a PC today, but on cheap, always-on devices.

The ability to use lightweight mobile devices will increase the speed of commerce and create brand new offerings that could not have existed before the advent of Cloud systems. Think of the new opportunities cars and highways created in the last tech wave: Suddenly mom and pop hotels and diners would be replaced by enormous companies. These companies provided low-cost but high-quality destinations consumers could count on.

I don’t know about you, but today I don’t rely on my smartphone without some sort of backup plan. These days I bank via my PC and travel with the understanding that the applications on my smartphone may or may not be usable when I’m not at home. This will change as all businesses embrace Cloud Computing.

What the McDonalds equivalent on the information superhighway will be in the coming years I can’t say with any certainty, but I am 100 percent sure that the equivalent to McDonalds, Marriott and Holiday Inn are in development today.

From the perspective of investing in technology, we can also be very confident that the significant enabling tech companies of the Cloud are for the most part standing in plain view today. The days of garage startups like Ford from the last wave and Apple or Dell from this one are over. The second half of tech waves are founded upon solid cash flows and significant market share holders. This is at the core of the STI investment model.

Future Winners

The future tech winners will be those that build out from their existing business model into either providing the technology to enable the next Holiday Inn chain or go into business to become the next consumer-based McDonalds. Therefore, what is critical is who is positioning themselves for the drive into the Cloud based on what capabilities they already have.   

Today, Amazon.com (NSDQ: AMZN) is the leader as far as Clouds go. It has roughly twice the market share of its competitors’ with its Amazon Web Services (AWS) as a public Cloud provider. In terms of annual revenue they have grown Cloud revenues to $10B. When one considers how they are dominating consumer web sales in conjunction with their AWS Cloud, one sees a serious Cloud company for the next decade.

The issue with Amazon is that despite its online retail success they have yet to book significant profits or pay a dividend. Furthermore, despite their lead in public Cloud, that is a future market years away from maturation. The Cloud is first going to develop in private Cloud deployments as all businesses have existing computing resources which they will convert to private Clouds initially.

Gartner’s Cloud analyst Thomas Bittman (http://www.gartner.com/newsroom/id/2599315) projects that it will be the end of 2017 before hybrid Clouds make up half of the Cloud market. Hybrid Clouds are the mix of private Clouds and Public Clouds. With the maturation of Public Cloud we can see how the acceleration of the Hybrid Cloud will occur. But it will be years before we see the move to largely public Clouds take hold in the marketplace. Given the volatility return we will see in 2014 this dynamic precludes Amazon from being a buy recommendation for STI, particularly with its very high multiple.              

I was at a conference recently where Google (NSDQ: GOOG) presented their public capabilities, and it was constructed all around their current capabilities. Given that Google makes most of its money from search, their presentation was on the speeds and feeds of their public Cloud offering. Since it is bad for Google’s search model when web surfers get results slowly, Google is leveraging the technologies that are unique to its business – fiber optic cables providing very fast connection speeds. They also tout their ability to provision resources, and they are indeed very fast in that regard. They have to be to constantly provision greater resources for their enormous Googleplex data centers that house copies of the entire Internet for increased search speeds.

Google also has high valuations and is still trailing Amazon, which currently looks like the better bet long term. Google’s entrance into Cloud is relatively new compared to Amazon, which has been in this space for many years now. Further, Google’s reliance on engineering over marketing strategies leaves us nonplused in their innogration strategy as well.

A public Cloud company we like the best of the big three public Cloud companies is Microsoft (NSDQ: MSFT). Microsoft has a slight lead for database Cloud services. Microsoft has a significant enterprise software business that will translate to strong revenue flows as private Clouds take hold in the marketplace.

Microsoft’s cash makes it a better investment through the volatility ahead while the market digests the recent naming of its new CEO. The new CEO could energize this sleepwalking giant, which has been following instead of leading. Microsoft’s financials have been so good of late we have even heard calls for former CEO Steve Ballmer to cancel his retirement. That would be the worst decision Microsoft could make in our opinion.

The companies that have already moved into Consumer Clouds have positioned themselves to advantage of the lightweight mobile consumer devices, which are exploding in increasingly larger volumes. These companies are positioning themselves to leverage 60 percent of the U.S. economy – consumer spending.

We have covered Apple (NSDQ: AAPL) and Verizon (NYSE: VZ) as our two favorites in recent articles. In fact, we identified Apple as “The One Tech Stock to Own in 2014” in our December article in this space. We also like Verizon, as it not only resells all of the best smartphones but is also an enormous cash machine leading the U.S. in cellular sales and a strong player in Fios TV programming sales. 

Both Verizon and AT&T (NYSE: T) are still taking share from the cable and satellite companies. Even though AT&T is number two behind Verizon, they are also standing up their own public Cloud offering to compete with Amazon, Google and Microsoft offerings. 

Our last word on Cloud – You must remember that the private Cloud is the market that will see the fastest growth for the next few years. The “Storage Kings” are going to be the direct recipients of growth as a result, two of which we evaluated in our inaugural issue. And below in our Sector Spotlight article we examine another company that could completely reverse its fortunes if it gets to the cloud in time.