A RULE BREAKERS SPECIAL REPORT

THE 3 KINGS OF CLOUD COMPUTING

VERSION 2.0

Motley Fool Rule Breakers

December 2010

The 3 Kings of Cloud Computing

Version 2.0
Brought to you by David Gardner and Tim Beyers

dmit it. Youve seen the footage of Microsoft (Nasdaq: MSFT) CEO Steve Ballmer sweatily invoking a crowd of software superstars. Developers! Developers! Developers! goes the chant. Seats empty, hands clap, and the assembled throng joins in what feels like a massive seance as if Ballmer is conjuring a powerful spirit wholl summon sharp-edged bits and bytes for the coming soft-war. Sound crazy? Perhaps, but its not far from the truth. Windows became what it is because developers saw fit to write code to support and extend it. Now theyre writing code for the Web. Techies call the process cloud computing. Rule Breakers calls it an opportunity for rebel investors like you to make a lot of money, starting with these three stocks. Plug into an electrical outlet, and youre tapping into a vast network that matches supply and demand across the grid. Now think of doing that for any computing need, and thats cloud computing uniting processing power, storage, applications, and more via networks. Networked systems can be more effective, solving business problems in groups rather than individually, because several brains are better than one. The human genome project was managed by a team of experts and a massive, networked computer system. Cloud computing applies this model to everyday business applications. Ultimately, cloud computing a scalable way to deliver all forms of computing services on demand: Just plug in, take (and pay for) what you need, and go. Its a classic disruptive technology and the stuff Rule Breakers are made of.

COMPANY SNAPSHOTS
Akamai (Nasdaq: AKAM)
Market Cap: $9.9 billion Recent Share Price: $54.12 52-Week Range: $24.50 - $54.39 P/E: 64.1 CAPS Rating: 4 out of 5 stars

Data as of 12/8/2010

Google (Nasdaq: GOOG)

Market Cap: $187.8 billion Recent Share Price: $587.14 52-Week Range: $433.63 - $630.85 P/E: 23.9 CAPS Rating: 3 out of 5 stars

Rackspace Hosting (NYSE: RAX)

Market Cap: $3.8 billion Recent Share Price: $30.15 52-Week Range: $15.15 - $31.42 P/E: 95.6 CAPS Rating: 3 out of 5 stars

VMware (NYSE: VMW)

Market Cap: $35.1 billion Recent Share Price: $84.74 52-Week Range: $40.21 - $89.18 P/E: 120.5 CAPS Rating: 3 out of 5 stars
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Salesforce.com (NYSE: CRM)

Market Cap: $19.0 billion Recent Share Price: $145.24 52-Week Range: $60.30 - $149.70 P/E: 263.4 CAPS Rating: 1 out of 5 stars
Special Report December 2010 rulebreakers.fool.com

Akamai Technologies (Nasdaq: AKAM)

Akamai (our No. 1 company for new money) is like a helicopter for Web traffic. Its private networkof 65,000 servers uses an algorithm, created at the Massachusetts Institute of Technology in the late 90s, todeliver data faster than would ordinarily be possible on the Internets crowded highways. The service is so popular that Akamais servers can deliver up to 15-20% of the Webs traffic every day, the company estimates. Bigcustomers are the reason. Microsoft, Sony (NYSE: SNE), Nintendo, and Apple (Nasdaq: AAPL) for which it serves up iTunes audio, video, and now, movie rentals all havelong standing relationships with Akamai. Computing in the cloud requires that data be delivered quickly. Akamai accomplishes this by via its algorithm but also physics; servers are positioned geographically close to users. And big clients appear happy to pay for the privilege. Akamais average customer spends $275,000 a year; many of those now spend $1 million or more a year. Video streaming may be why; theres plenty of uncertainty over who will control video on demand. So long as the providers find it uneconomical to build a content delivery network from scratch, Akamai will continue to benefit. Software should also spur growth since tuning Akamais algorithm for new services has proven effective. Application acceleration, now a business predicated on delivering executable software code as securely as a music file, is a classic example.the top dog, an aggressive mover, and a worthy buy for the rebellious portion of your portfolio.

Simplicity breeds growth. VMware has grown its revenue at a compounded annual growth rate of 32% over the past three years. Net profit is also up. Returns on equity and invested capital key determinants of management excellence are also strong. Theres uncertainty, but the companys potential remains undeniable.

Google (Nasdaq: GOOG)

The cloud computing company that has been thus far ignored: Google (Nasdaq: GOOG). Its digital advertising business is thriving. Revenue was up 22% over the past 12 months. In spite of this, weve seen a stagnant stock price shares of Google are up just 7% since Rule Breakers recommended it in June of 2008. But thats the Google of today. Its the promise of a richer tomorrow that has ensnared developers. As a group, they appear to love App Engine, which, like salesforce.coms Force, is a platform for creating software for the cloud. More than 75,000 are already working with it. Another 80,000 are on a waiting list, trade magazine CIO reports. And the Big G has other advantages when it comes to cloud computing: Infrastructure: Google reportedly has at least 450,000 low-cost servers that leverage open-source software. Better still, thanks to its iconic search engine, these machines are designed to work cohesively. Partnerships: Companies hoping to profit from the shift to cloud computing are teaming up with Google. Salesforce. com has joined the Google Apps initiative, and IBM is working with Google on cloud computing for university research. Experience: Google Apps isnt about to replace Microsoft Office. But with an estimated 1 million users of its online software, Google is gaining valuable experience delivering cloud computing services that others lack and that makes App Engine all the more useful. For its part, Microsoft plans to add 20,000 servers per quarter to its Web infrastructure. And its Microsoft Online Services looks like an experimental platform for cloud computing though it may be little more than an attempt to keep Windows from irrelevance. Microsoft just-announced plan for selling hosted online services such as email, Web meetings, and collaboration is a move in the right direction for the company, ComputerWorld columnist Preston Gralla wrote recently. But its not yet nearly good enough to fend off Google. Microsoft is going to have to deliver more, or it could ultimately face the loss of
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VMware (NYSE: VMW)

VMware, by contrast, helped popularize virtualization technology. Think of a server as a closet for storing data. VMware makes it so that your clothes arent kept in heaps but organized into labeled containers, each with everything youll need for the day ahead. Digitally speaking, this means that VMware takes a block of computing resources processing power, storage, and applications data and divides it into distinct, usable chunks. And that, interestingly, can lead to both greater security and efficiency. Why? We often spread out and duplicate data across systems to protect servers from viruses and crashes. The result is that servers are underused companies pay a lot for all this capacity, then use only 5% or 10% of it. VMware alters the equation by transforming a network into a pool of computing resources. Or, keeping with our theme, a cloud. What makes VMware special is how simple its software is to use. One example: Hypervisor, a toolkit for creating pools of computing power that can be accessed directly in servers from IBM (NYSE: IBM), Dell (Nasdaq: DELL), and HewlettPackard (NYSE: HPQ), among others.
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Special Report December 2010

massive amounts of revenue. Ballmer is right: Its all about the developers. When it comes to cloud computing, its Google not Microsoft that is winning them over. Thats the sort of rebel you run with, Fool.

Hosting is a brutally competitive business because Rackspace and its peers create exactly nothing thats new. Rather, Rackspace takes software from others, installs it on systems in one of its eight data centers, and then ensures that it works as advertised. If that sounds terrifyingly replicable, it is. IBM (NYSE: IBM), AT&T (NYSE: T), Switch & Data Facilities (Nasdaq: SDXC), Amazon.com (Nasdaq: AMZN), and many others offer some form of hosting. Rackspace isnt the largest, either: Both Big Blue and Ma Bell employ far more servers, switches, load balancers, and storage. But Rackspace is unique for what it guarantees perfection. If a customers application goes down, at any time, for any reason, Rackspace will refund the fees. No other hoster is crazy enough to claim that. But Rackspace is driven by the mission to be one of the worlds great service companies, and it places reputation and reliability first, right down to copyrighting the catchphrase Fanatical Support. Refunds have been small and outpaced by revenue growth. Crazy has turned out to be a completely sane if Rule Breaking business decision. And the numbers bear this out. Revenue improved 21% to $698 million last year, while cash from operations gained 35% to $211 million. And analysts expect it to grow 22% annually over the next five years a number we think it could easily exceed. Of course, Rackspace isnt Google, and the risk with this company is that IBM, AT&T, or any of the other big data center operators could decide to get a lot more focused on hosting and undercut Rackspaces already-thin margins. Management seems to know this all too well and thus the obsessive focus on customer service. If that service record became tarnished, wed think about selling. But even if Rackers continue to rule and the stock soars, venture investors Sequoia and Norwest could start dumping shares and sink an otherwise good growth story. Also, with debt and years of capital expenditures still ahead of it, Rackspace could significantly dilute existing shareholders for the sake of growth capital. Im willing to accept this risk; were in hypergrowth times when it comes to cloud computing. But if growth slows to the point that Rackspace fails to produce excess cash from operations, wed recommend changing course The bottom line: Rackspace is more than a dot-com survivor; its also one of the great growth stories of the past decade. Now its entering a fresh phase of growth fueled by the demand for cloud computing services. You can bet Rackspace will attack this opportunity with its signature fanaticism, and if it succeeds, as I believe it will, multibagger returns will follow. David owns shares of Microsoft, Nintendo, and Apple. Tim owns shares of Akamai, Apple, Google, and IBM. The Fool

Salesforce.com (NYSE: CRM)

CRM is the software that lets businesses monitor their interactions with customers and prospects. Much like inventory management helps companies track parts, CRM helps them track deals. Its big business and Salesforce makes it even easier by putting everything online and making it accessible through an ordinary browser. The company sells monthly subscriptions to more than 80,000 corporate clients who access its servers. Renting makes sense to these customers, who would rather save money upfront by allowing Salesforce to own the data centers. Those who use Oracle, SAP, and Microsoft arent so lucky. Not only do they have to buy expensive hardware, but they also need the expertise to maintain it. In that sense, Salesforce is a classic cloud computing company. It delivers functionality over the Web that youd ordinarily install on a PC or server. And theres more to the story: Salesforce wants to be the warehouse for companies that put their data online. As Oracle has been for on-site business software, Salesforce wants to be for Web-based business software. Success doesnt come cheap, however, and bears will tell you that Salesforce is far too expensive to own, pointing to its 200plus price-to-earnings ratio as proof. But if you look at cash flow, Salesforces valuation is less intimidating. Bottom line: Salesforce offers price momentum along with visionary leadership, and a strong market position. Its the perfect Rule Breaker even in troubled times.

Rackspace Hosting (NYSE: RAX)

Pat Condon is one of the three founders of Rackspace Hosting (NYSE: RAX), but he never really wanted to be in the hosting business. He wanted to be in the coding business. It was 1998, and everyone wanted to be a coder which meant that no one was figuring out how to host all the code that was migrating to the Web. Rackspace transformed that unfulfilled need into a business opportunity. Fast-forward to today: The dot-bomb days are over, but the cloud computing era has begun, creating a new opportunity for hosting providers like Rackspace, now over 99,000 customers strong, to handle the software and services that deliver data to hundreds of millions of users around the world.

Motley Fool Rule Breakers

Special Report December 2010

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