General Electric Company Teams Up With Microsoft Azure

General Electric Company's (NYSE:GE) recently announced partnership with Microsoft Corporation (NASDAQ:MSFT) makes GE's cloud based platform-as-a-service (PaaS) Predix available on Microsoft's cloud service Azure. The deal between the two iconic blue chips makes great copy, but what does it mean for the investment case for General Electric stock?

General Electric Company is connecting railroads to the industrial internet. Image source: GE Digital. 

READ THE FULL EQUITY RESEARCH ARTICLE LINKED

More Trouble for Rackspace

Life just got a bit harder for cloud computing services company Rackspace Hosting. Google  aggressively reduced prices across its range of cloud services recently, while deep-pocketed competitors like Amazon, Microsoft, and Oracle are committed to offering infrastructure as a service, or IaaS, at highly competitive rates. In addition, Cisco Systems is planning to invest heavily in offering IaaS. While much of this is known to investors, it's sometimes easy to lose site of the fundamental reasons why these companies are doing this and why competition is only going to get more intense.

Why companies are investing in IaaSSimply put, it works. The companies that have transitioned to offering their services and applications on a software as a service, or SaaS, basis have seen a transformational improvement in their prospects. The three leading examples of this change are Adobe, Autodesk, and Intuit. Investing Fools already know how and why these companies are outperforming the markets.

 

READ THE FULL ARTICLE LINKED HERE

How Oracle is Making the Right Changes

The market's valuation of Oracle continues to suggest doubt over its future direction. It's traditional on-premise on-license sales are being threatened by pure-play software as a service, or SaaS, companies like Workday and Salesforce.com. Meanwhile, analysts are also questioning its future margins, given that management declared an intent to be "price competitive" with Amazon Web Services and Microsoft's Azure. Are the skeptics right about Oracle, or is the stock a good value?

Oracle reports a good second quarter
After disappointments from IBM and Cisco, investors have approached Oracle's recent results with caution, despite the fact that the numbers came in slightly better than expected.

• New software licenses and cloud software subscriptions (26% of revenue) grew 1% constant currency growth vs. internal guidance of -4%-6% growth.

• Hardware systems product sales declined 2% in constant currency vs. internal guidance of  -9%-1% growth.

• Non-GAAP earnings were $0.69 vs. internal guidance of $0.65-$0.69.

Although new software licenses and cloud subscription growth appears weak, Foolish investors should note that the company came up against some very strong numbers from last year's second quarter.

Source: company presentations.

Oracle's management articulated that its mix of software sales had a larger share of renewals and annuity deals versus new license deals. This kind of shift usually involves trading off some upfront revenue for an income stream over time. Indeed, Oracle's management argued, "you would think it would take you a couple to three years to get to that full productivity of the equivalent of a recurring stream of revenue to what you would have typically seen in license."

In other words, Oracle's revenue is likely to be negatively affected in the short term with this shift toward subscription-based sales.

The geographical breakdown confirmed Oracle's strength in the Americas, with sales up 5%, along with "good growth" in China. However, the real talking point is how aggressively Oracle is seeking to expand its cloud infrastructure services.

Oracle takes on Microsoft, Amazon, and Rackspace
As you would expect from a megacap tech company, Oracle's cloud offerings include SaaS, applications, and infrastructure. However, on its recent conference call, Oracle's CEO, Larry Ellison, explained that his company's plans involve being "price competitive" with Amazon, Microsoft's Azure, and Rackspace. Ellison also plans to make Oracle "highly differentiated at both the platform level and the application level."

The plan can easily be criticized for potentially sacrificing infrastructure margins at the expense of chasing future revenue. The market is competitive enough already, as Microsoft has already promised to match Amazon on pricing and features.

Oracle needs to address the threat that pure-play SaaS companies like Salesforce and Workday will grab market share within their respective niches of customer relation management and human capital management. Therefore, a strategy like this will help efforts to retain leadership with long-term recurring revenue from cloud applications.

Similarly, Microsoft and Amazon have their own services that will benefit from selling cloud infrastructure at less-than-optimal prices. The important strategic issue for Oracle is to remain relevant as SaaS solutions become more important.

Oracle's financial firepower and marginsOracle has the financial firepower to make these moves. It's trailing twelve month free cash flow generation of $14.6 billion represents approximately 9.6% of its enterprise value. Furthermore, Oracle is investing in dedicated sales teams to compete for business against Workday and Salesforce. Sales and marketing expenses increased 12% in constant currency during the quarter, as Oracle built out sales capacity to win future business in the cloud.

All told, these initiatives may trim margins, but Oracle has a lot of financial leeway, and so does its valuation. Despite a 20% rise in the last six months, the stock still trades on just 12.5 times forward earnings to May 2014. Operating income margins fell to 36% in the first half, versus 37% last year, but 80% of the increase in operating expenses came from investments in sales and marketing.

The bottom line
Investors can be quick to criticize management for failing to adjust to structural changes, but Oracle is making significant efforts to manage the transition of software into the cloud. Investments in sales capacity, infrastructure services, cloud-based acquisitions, and efforts to respond directly to the threat posed by Salesforce and Workday are all demonstrations of intent.

Oracle is responding to structural changes in its marketplace, and it will take time to come to fruition. However, the stock's valuation suggests it can withstand some margin erosion along the way.

Rackspace's Business Model is Being Challenged

There is a difference between saying that a company is good, and saying that it is a good investment. In the case of Rackspace , its current business trajectory is suggesting that it's not a good investment even though that doesn't mean it’s not a great company. Unfortunately, increasing competition within the cloud computing provision market from the likes of Amazon Web Services  and Microsoft's   Azure is threatening Rackspace, even as the company improves its already high level of service.

Rackspace's margin
It's difficult competing with Microsoft and Amazon in the best of times, but it's a lot harder when they are both cutting prices in order to win market share in a fast-growing business. Throw Google into the mix and its almost unfair. The fact is that those three tech giants can easily subsidize lowering prices (and therefore margins) because they have add-on advantages to winning new business.

Indeed, AWS is reported to have recently cut prices by 10% across all its regions, and it's hard not to think that its response to Microsoft's aggressive discounting actions. The two companies have seemingly been locked in a price battle, the effects of which are starting to show in Rackspace's margins.

While its revenue was up 15.6% in the third quarter, Rackspace's operating income margins fell to 9.4% for the first nine months compared to 12.9% last year. Moreover, the third quarter saw operating income margins come in at just 7.1%.

Rackspace invests in order to grow
In defense of the company, it's currently investing to support growth created by customers adopting its OpenStack public cloud options. In addition, its management has long claimed that its "Fanatical Support" is its unique selling point within a competitive industry. Unfortunately, a high level of support usually implies a high level of investment, and Rackspace appears to be running hard in order to stand still on that front.

At the start of the year, Rackspace had forecast full-year capital expenditures of $375 million--$445 million and customer gear expenditures of $235 million-$275 million. Fast forward to the latest results and capital expenditures are now forecast to come at $460 million--$510 million. While "north of $10 million" of the increase is due to buying land for a datacenter, the rest is because it is investing in its cloud infrastructure and customer gear. In fact, customer gear expenditures have already hit $233 million this year. It's safe to assume that they will come in higher than the forecast at the start of the year.

These facts play to the heart of the questions with Rackspace. Can it leverage up its investments and start to generate meaningful cash flow in future? Alternatively, is it forced to invest in continually buying customer gear so that its customers can benefit from outsourcing IT expenditures in order to generate growth?

The following chart shows operating cash flow, capital expenditures, and customer gear expenditures as a share of income over its last four quarters. The hope is that Rackspace will be able to generate free cash flow (operating cash flow minus capital expenditures) over time.

Source: company presentations, author's analysis.

Unfortunately, it looks like Rackspace is finding it difficult to generate meaningful cash flows. As 2013 has gone on, its customer gear requirements have gone up. Consequently, customer gear now makes up nearly 67% of capital expenditures. Its one thing to provide fanatical support to generate revenue growth, but it's another thing to generate cash to be returned to shareholders.

Rackspace's bottom line
All told, conditions look like they are getting tougher for Rackspace. Competition from Microsoft and Amazon appears to be pressuring prices, while it's having to increase expenditures in order to service clients.

Rackspace has generated just $18.7 million generated in adjusted free-cash flow (its own figures) so far in 2013, but sits on a current market cap of $5.9 billion. Meanwhile, it still hasn't demonstrated that its business model can generate the kind of cash flows that could justify its valuation in future. It doesn't look like a good value to me.

Digital Realty Trust Signals Problems in the Data Centres

One week after datacenter services company Equinix (NASDAQ: EQIX  ) disappointed the market with a lackluster set of results, it was datacenter REIT Digital Realty Trust's (NYSE: DLR  ) turn to indicate that industry conditions are getting tougher. But is this a short-term growth hiccup or a longer-term problem? And with behemoths like Google (NASDAQ: GOOG  ) and Amazon's Web Services, or AWS, rolling out their own datacenters, are Equinix and Digital Realty headed for more difficulty?

Digital Realty reality
Digital Realty reported funds from operations, or FFO, of just $1.10 in the third quarter compared to analyst consensus of $1.20. FFO is just a metric that REITs use to equate to EPS. Although $0.07 of the "miss" is due to a rent expense adjustment, its core FFO still only came in at $1.16.

Moreover, its guidance for 2014 was disappointing. Quoting from its conference call:

We are revising our 2013 FFO per share guidance to $4.60 to $4.62, down from $4.73 to $4.82 previously, and revising guidance for 2013 core FFO per share to $4.65 to $4.67, down from the prior range of $4.74 to $4.83

This adjustment is a reduction of 3.5% or $0.17 of EPS at the mid-point of guidance, but to be fair to Digital Realty, $0.07 is due to the aforementioned rent adjustment and $0.03 is due to a joint venture with Prudential.

However, the worrying bit is the $0.06 that is due to "delayed lease commitments." In other words, customers are not utilizing the datacenter space—that they signed up for—as quickly as Digital Realty had anticipated. This is a sign of a maturing industry, or at least, one in which the customers have the upper hand with regard to pricing negotiations. Moreover, in its earnings release, Digital Realty gave preliminary guidance for 2014, and informed investors that rental rates on renewal leases are expected to be roughly flat on a cash basis, along with operating margins "approximately 25-75 basis points lower than the historical run rate."

In other words, Digital Realty is finding it harder push through price increases. Another sign of a maturing industry.

Equinix deals with reality
These industry trends are confirmed when looking at Equinix's recent results. There is a more detailed analysis of them linked here.

Equinix had lowered earnings guidance already this year, and its third quarter results also contained some negative nuances. Its deal sizes are getting smaller, while its sales cycles are lengthening. However, Equinix's management argued that it was primarily a consequence of delays caused by enterprises planning more complex hybrid cloud deployments:

I don't believe they are really just driven per se by macroeconomic uncertainty or a broader enterprise anxiety or anything like that... ...just driven by the fact that the decisions of CIOs to move to sort of hybrid cloud infrastructures

Partially in response to these developments, Equinix strengthened its relationships with Microsoft's (NASDAQ: MSFT  ) cloud platform, Azure/and also with AWS. The idea being that Equinix's customers will find it easier to build out their hybrid clouds from within its [Equinix] infrastructure. In fact, Equinix sees the development of cloud services from the likes of Google, Amazon and Microsoft as a net positive in the long-term.

The bottom line
Essentially, the evidence is that the datacenter market is maturing and pricing power appears to be moving away from the datacenter providers and toward the buyers. Meanwhile, its incumbents are still investing in new capacity. Investors in datacenter providers InterXion, Telecity and DuPont Fabros should take note.

Whether the issue is going to be prove relatively short term (as is implied by Equinix's arguments over the hybrid cloud deployment issue), or if it's simply a function of oversupply, the near-term outcome is likely to be similar. The industry is facing some pressures and cautious investors should wait until there are signs of pricing power returning.

Equinix Investors Should Brace Themselves

What do you do with a stock with which you fear near-term risk, but are confident in its long-term prospects? That's pretty much the problem that investors in data-center provider Equinix (NASDAQ: EQIX  ) are faced with right now. While its third-quarter results didn't bring lower full-year estimates again, they were accompanied by the sort of commentary that suggests the company is still facing headwinds.

Equinix responds to a changing market
In its previous quarter, Equinix had lowered its expectations for growth in the second half due to a combination of weaker conditions in Germany, a longer sales cycle within its enterprise markets, and a reduction in average deal size. Unfortunately, the narrative around the last two issues continued in the third quarter. Fortunately, Equinix is responding to these changing market conditions.

On its conference call, Equinix outlined that deal sizes continued to be smaller this year, and its intention was to do "more transactions every quarter" as it refuses to take on board larger scale work at unattractive price points. This is fine, but it increases the pressure on its sales team to find suitable deals in a market that is changing.

While there is little that Equinix can do about lengthening sales cycles, per se, its measures to extend contracts for 70% of its top 50 customers helps to secure long-term revenue streams. Moreover, it insulates Equinix from some future pricing competition and frees up management resources in order to chase other deals.

And finally, it's strengthening its relationships with partners like Amazon (NASDAQ: AMZN  ) Web Services, or AWS, and Microsoft's (NASDAQ: MSFT  ) cloud platform, Windows Azure. Both measures are intended to offer Equinix's customers more flexibility to build out their hybrid cloud infrastructure.

What is lengthening sales cycles?
The relationships with Amazon and Microsoft are important, because they help address what Equinix believes is the reason why the environment has gotten tougher. On its conference call, management outlined that more of its customers were seeking to build out more complex infrastructures, such as the hybrid cloud.

In plain English, the hybrid cloud just means an infrastructure where private and public clouds are working in combination. As a network-neutral data center, this shouldn't be a problem for Equinix. In fact, its co-location data centers benefit from these trends because customers can connect with various cloud service providers from within Equinix's data centers. However, the snag is that the increased sophistication of the hybrid cloud is lengthening sales cycles. Speaking on the issue on the conference call, management had this to say:

I don't believe they are really just driven per se by macroeconomic uncertainty or a broader enterprise anxiety or anything like that...just driven by the fact that the decisions of CIOs to move to sort of hybrid cloud infrastructures...And there are sales cycles that need substantive technical support.

In this context, the agreement with Microsoft to extend the strategic relationship by enabling connectivity to Windows Azure through Equinix's data centers makes a lot of sense. Similarly, Equinix has a deal with Amazon which allows Equinix customers to connect their IT infrastructure directly with AWS.

If customers are taking longer to define their hybrid cloud architectural needs, then these sorts of deals with Amazon and Microsoft will surely help them by granting them more flexibility. In addition, Amazon and Microsoft will benefit too.

What to do with Equinix?
In the long-term, Equinix looks set to be a net beneficiary of these changes. However, the problem is that it could come under near-term pressure. Moreover, it's a competitive industry in a high-growth expansionary phase. Indeed, rivals such as Telecity and InterXion haven't been slow in building out capacity. If sales cycles continue to lengthen, then pricing pressure could appear as the leading players start to fight to fill their growing capacity.

The current enterprise value is around $11.8 billion, and with a 2013 forecast of around $620 million-$640 million in adjusted discretionary free cash flow -- a useful measure that Equinix uses to demonstrate its underlying performance -- the stock looks like a good value. The potential for REIT conversion should turn this stock into a dividend favorite, and long-term demand conditions look good. However, the near-term uncertainty means investors should be aware that conditions could get worse before they get better.

Citrix is Dealing Well With Changing Trends in IT

It helps to have powerful friends, and very few companies have allies as strong as IT virtualization specialist Citrix Systems (NASDAQ: CTXS  ) . With partners Cisco Systems (NASDAQ: CSCO  ) and Microsoft (NASDAQ: MSFT  ) helping to push some of Citrix's newer solutions, the company looks well-positioned to grow, even as its core desktop virtualization sales are slowing.

Citrix's changing end market

Desktop virtualization allows companies to centralize their application software management so that their hardware (PCs) become virtual devices. Installing new applications on a single central computer -- and having those changes instantly show up on every employee's PC -- makes managing IT infrastructure a lot easier for big companies.

The big story in computing over the last few years has been the shift from desktop PCs toward mobile devices and cloud-based solutions. This powerful trend has left some tech behemoths, like Microsoft and Intel (NASDAQ: INTC  ) , struggling to remain current.

Simply put, Microsoft's Windows has very low penetration on mobile devices. Meanwhile, Intel has been too slow to develop chips for the new ultra-mobile world, and the second half of 2013 is going to be an important period in its long-term plans. Within those six months, Intel is releasing a few new chips with which it is trying to establish a foothold in the ultra-mobile market.

All of this forms the basis for discussion of the challenges facing Citrix in 2013. If PCs are no longer the dominant force in computing, and Windows is no longer the default standard operating system, where does this leave Citrix's core desktop virtualization market?

XenMobile to the rescue

Citrix hasn't been slow to adjust to the changing reality. In the first quarter, it released its enterprise mobility solution, XenMobile. Unfortunately, it seems to have affected its growth pattern. Indeed, at the time of its first-quarter results, Citrix argued that the XenMobile release caused customers to delay orders as they assessed which type of solution was optimal. A chart of product revenue growth reveals how choppy the company's growth has been as a consequence.

Source: company accounts

Growth in products and licenses is the key to growth in the other revenue streams.

The second quarter saw an impressive bounce back in overall product and license sales growth. But within that, mobile and desktop only generated a 2% increase. So, even though mobile and desktop revenue actually rose 11%, Citrix's future growth is not assured.

However, on the conference call, management was keen to stress that: "...regarding mobile and desktop, I believe that the growth will accelerate as we look into Q3 and Q4. And that's a function largely of productivity starting to flatten out and mobile starting to ramp."

Desktop virtualization and application delivery controllers

Alongside the plan to push XenMobile -- which, by the company's own admission, is hurting its efforts to sell its stand-alone desktop solutions -- Citrix is also releasing its latest desktop virtualization solution, XenDesktop 7. Microsoft has a vested interest in helping this solution succeed because it brings Windows virtual desktop and apps under one structure, encouraging corporations to keep running Windows.

While XenMobile and the XenDesktop 7 are about generating future growth in mobile and desktop, the current star performer is Citrix's networking and cloud division. The latter grew revenue at a whopping 46% in the quarter, with product license revenues up 54%. In fact, the share of total revenues coming from networking and cloud solutions has risen from 16% in 2010 to around 22% so far this year.

Source: company accounts

The biggest contributor to growth in networking and cloud revenue came from Citrix's application delivery controller, or ADC, NetScaler. F5 Networks (NASDAQ: FFIV  )  is the global leader in this market, but Citrix's NetScaler has a couple of key advantages.

First, Citrix is able to include NetScaler as part of its virtualization offerings. Indeed, it announced that it signed 550 desktop virtualization orders in the quarter on this basis. Second, Cisco Systems is a key partner of Citrix, and since Cisco stopped investing in its own ADC (called ACE), the two companies have teamed up to sell NetScalers.

There is more growth to come. On the conference call, management argued that the replacement orders for Cisco's ACE only contributed a "minor amount" to the current results. In other words, Citrix still has a significant amount of Cisco's installed base of ACE customers to target in the future. Naturally, F5 will also fight hard for this business, but it's difficult to conclude that Citrix isn't taking market share at the moment.

The bottom line

Essentially, Citrix investors should be looking for a few things going forward:

• A strong return to mobile & desktop product license growth in the second half

• Ongoing sales execution from NetScaler

• Its partners, Cisco and Microsoft, continuing to integrate functionality with Citrix's solutions

The desktop virtualization market is far from dead, and still has some good growth catalysts. In addition, the changing tides in IT spending are about integrating solutions across multi-platforms, so Windows still has a key role to play. Meanwhile, XenMobile and NetScaler promise to offer alternative sources of growth.

Finally, Citrix's valuation does not look historically expensive.

CTXS Price to Cash Flow TTM data by YCharts

Provided it can execute on the above points, the analysts' consensus price target of $80 looks achievable. It's well worth a look.

What Intel Needs to do in the Second Half in Order to Hit Guidance

One of the most fascinating things about investing is how you can find yourself faced with the same sort of questions over and over again. In the case of Intel (NASDAQ: INTC), you're coming up against some classic propositions. What if you like the long term value of the stock, but are concerned about the near-term risk? Moreover, you might like the forward guidance, but how much do you believe in it?

Intel lowers guidance, again

It’s no secret that Intel’s core PC market has been weakening for some time, and the company has-- by its own admission-- been slow to react to the changing trend towards ultra-mobile PCs and smart phone devices. Indeed, it recently lowered its expectations for PC sales in 2013, but raised them for ultra-mobile devices.

Furthermore, the market didn’t have to wait long before Microsoft (NASDAQ: MSFT) confirmed these trends by reporting a decline in its Windows business, as the new device market takes precedence over traditional PCs.  In fact, Microsoft’s Windows revenue declined 5%, while it estimated that the consumer PC market was down a whopping 20%.

In the good old days, the release of a new Windows operating system was like a red rag to a tech bull, particularly for Microsoft and Intel investors. Unfortunately, those days are gone. Microsoft’s Windows 8 has hardly set the world on fire, and some analysts have blamed its release for slowing down PC sales. Consequently, Microsoft is struggling to remain relevant on new devices such as smart phones.

Turning back to Intel, its lowered expectations for PC sales (the PC client group currently makes up more than 63% of sales) caused it to lower full-year revenue guidance to ‘approximately flat’. Equally importantly, it lowered its full-year gross margin forecast to 59% from 60% previously.  On a more positive note, Intel also demonstrated its ability to adjust to weakening sales by lowering its capital expenditure forecast by $1 billion, to $11 billion.

I want to focus on gross margins, because this metric has tended to guide the share price.

INTC Gross Profit Margin Quarterly data by YCharts

It’s not a failsafe indicator, but generally speaking, you would want to buy Intel after its gross margins have bottomed. The good news is that on the conference call, management guided towards gross margins improving to 61% in the third quarter (Q3) and “at or maybe a little bit higher” for the fourth quarter (Q4).

So is it now the time to buy Intel?

The answer depends on your level of belief in the guidance. In order to graphically demonstrate this, I’ve created this chart from company accounts, using the latest guidance given by the management. Intel forecasted $13.1 billion in revenues for Q3 and full-year revenues to be flat.

Clearly, the guidance assumes a return to growth in Q3 & Q4. Furthermore, note that these two quarters tend to be the most important for Intel. In other words, the second half performance will be critical to Intel hitting its guidance.

A few bullet points on what bulls might look for:

• The second half will see the launch of the Bay Trail processor, aimed at the entry-point ultramobile device market.

• The energy-efficient Haswell processor should start to see sales ramp up as manufacturers integrate it into their new devices.

• LTE-phone-based sales will start to accelerate.

• Intel predicts its data-center-based revenues will grow in the low double digits for the full year.

• The company is starting to lap weaker comparables from last year.

• Management forecasts that an improving macro environment will lift Intel’s sales.

The key factors will probably be how well Haswell and Bay Trail are adopted by original equipment manufacturers (OEMs). Intel is trying to muscle its way into the ultra-mobile market currently dominated by ARM Holdings' (NASDAQ: ARMH) processor designs. This is becoming an ever-more-important battle because -- as demonstrated above -- the trend towards mobile devices is accelerating. So far, the refusal to license ARM-based architecture for its chips has seen Intel struggle to compete against competitors like QUALCOMM (NASDAQ: QCOM) in the mobile device market.

In the end, the key decision makers in the Intel vs. ARM battle are going to be the device makers. If the latter are confident that they can create commercially viable products via shifting to Intel, then the battle will start to be won. Moreover, you can form your own view by looking at which tablets, ultrabooks, and mobiles are starting to be released with Intel chips.

The bottom line

In conclusion, the second half promises to be a better one for Intel -- and it needs to be, for the company to hit its guidance.  Thinking longer-term, even if Intel does fail to establish itself in the ultra-mobile device market, it could always change tack in future and start to license ARM's core technology. This is something for investors in ARM (positively) and Qualcomm (negatively) to ponder.

However, the near-term risk is if Intel misses the targets outlined above. Frankly, I think Intel will have challenges to hit these targets. But in any case, its valuation of around 12 times earnings will make it attractive to value investors who can stomach near- to mid-term volatility.