Cloud platform providers powering digital transformation and investing gains
Updated: Oct 30, 2020
Part 1 of 6: Assessing the macro trend
The California Gold Rush (1848-1855) created a lot of wealth, but more often than not it wasn't the speculators coming from across the United States and abroad that became rich overnight. It was usually those that sold the speculators the supplies necessary to search for and dig up the gold that became wealthy.
The Gold Rush entrepreneurs weren't just selling miners the pickaxes and shovels. Levi Strauss, an immigrant from Germany, set up a dry goods company in San Francisco to outfit California gold rushers with a tough denim "waist overall" pant. Today those waist overalls, now called blue jeans, built a clothing empire.
This strategy of generating wealth from the supplies needed to produce a product, rather then the product itself is called a "Pick and shovel" play. The picks and shovels needed for today's modern gold rush are the cloud technologies used by developers building apps and services powering digital transformation.
The digital transformation gold rush is just getting started. Worldwide spending on the technologies enabling digital transformation is forecasted to reach $2.3 trillion in 2023, according to the International Data Corporation (IDC)Worldwide Semiannual Digital Transformation Spending Guide. Digital transformation spending is expected to steadily expand throughout the 2019-2023 forecast period, achieving a five-year compound annual growth rate of 17.1%.
This data from IDC could now be under stated. The work from home and learn from home model, thrust upon us by the COVID-19 pandemic, has accelerated digital. The impact of COVID-19 on digital transformation is best summarized by Microsoft CEO Satya Nadella:
“We’ve seen two years’ worth of digital transformation in two months. - Satya Nadella, CEO, Microsoft
Digital transformation means a lot of brick and mortar companies are now becoming software companies. In my recent post Finding the next digital transformation investing homerun I profile three companies I feel are retooling themselves successfully for this sea change - Home Depot, Nike and Starbucks. To meet their customers high expectations these companies had to build amazing digital experiences, and do it quickly, or risk obsolescence. Despite hiring tens of thousands of developers to meet this customer demand, they didn't do it alone.
This is where "pick and shovel" cloud platform companies come in. They are decomposing the software stack into a set of APIs (Application Programming Interface), selling them as a service so developers can focus on what customers really want.
One of the more notable examples of these types of cloud platform services is Twilio, a communication as a service provider. Rather than build a custom video call experience as part of their app, developers plug in Twilio's API and (ta-dah) have a best in class video experience simply by copying and pasting a few lines of code. Co-founder and CEO of Twilio Jeff Lawson describes it as follows:
“We have taken the entire messy and complex world of telephony and reduced it to five API calls.”
With APIs such as those made available by companies like Twilio, developers can stich together all of these best in class building blocks from cloud service providers and build their apps much faster, more scalable and more globally than if they had to build from scratch.
The extent to which these 3rd party API building blocks are used by developers is more than you would imagine. Take Uber as an example. Much of Uber was assembled using 3rd party APIs. The Google map API, Twilio's messaging API for in-app communication between driver and passenger, Elastic search for matching drivers with passengers, are some examples.
Staying within the transportation industry to borrow an analogy, just like Ford doesn't build all of the components that go into their cars, developers don't need to build all of the infrastructure that goes into their apps. Platform providers like Twilio for communications, or Microsoft Azure or Amazon Web Services (AWS) for compute, storage and artificial intelligence (AI), have become the supply chain for developers building apps.
This supply chain of digital building blocks is the fuel behind the pace of digital transformation we are now experiencing. It has all culminated in amazing investor returns for those individuals with the foresight to buy in early:
Twilio (NYSE: TWLO) investors that bought into its IPO have seen returns of 97%+ over a three year period
DocuSign (NASDAQ: DOCU) provides an API for developers to quickly integrate DocuSign e-signature functionality into their apps and web sites. Investors that bought at the IPO price of $38 have realized 400%+ gains in two years.
Okta (NASDAQ: OKTA) offers developers platform services to easily bring identity management into their apps. Investors lucky enough to invest in Okta in April 2017 have seen their investment grow 8.5 times in 3 years.
And now with the accelerant of stay in place orders brought upon by COVID-19, I believe the growth of these platform service providers is about to go even faster.
The question for all investors looking for growth is "where can I find the next set of pick and shovel cloud platform service providers powering digital transformation that will transform my portfolio?"
If you've read my prior posts you know I like to evaluate stocks using objective criteria that I think best match the type of investment opportunity I'm analyzing. The end goal is to uncover the best bet for my money today in the space. With this thematic of cloud platform service companies I'm going to borrow from the criteria I outlined in my How to pick tech stocks that deliver wealthy returns post and modify it slightly to better fit this space.
Characteristics of High Growth Potential Cloud Platform Service Stocks
For more specific guidance on evaluating the strength of a company's platform check out this great article from Bessemer Venture Partners - Eight laws for developer platforms.
In assessing the level (or not) of developer love bestowed on a company I'm evaluating I like to check developer feedback on twitter, blogs, StackOverflow and other social listening mechanisms.
In this six part series I will analyze what I think are the five best cloud platform investing opportunities using the above criteria.
Up first is the edge computing platform Fastly (NYSE:FSLY). Follow me on Twitter @OwlWealthy to read my analysis when it's fresh off the press.
I will post my evaluation of each one of my top five best cloud platform investing opportunities every few weeks, culminating in my selection of the best of the bunch.