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Jeff Bezos Is Fearing Google's Next $20 Billion Business

NEW YORK (TheStreet) -- Google's (GOOG) next $20 billion business may take aim at Jeff Bezos-led Amazon (AMZN - Get Report) and not Apple (AAPL), as the company ramps up various initiatives, the latest being Google Computer Engine. Google Computer Engine may be a $20 billion business by the end of the decade, competing directly against Amazon Web Service for the hold of the infrastructure-as-a-service (IaaS) market.

Bernstein Research analyst Carlos Kirjner said in a Friday client note he believes Amazon's (AWS) will reach revenue of at least $20 billion by the end of the decade and that Google's Computer Engine may end the decade with an equally profitable and large cloud infrastructure business. "Together, Amazon and Google's cloud business could very well exceed $40 billion in revenues by the end of the decade, and perhaps much more," Kirjner wrote.

The way Kirjner sees it there are more than a handful of players trying to win the infrastructure-as-a-service (IaaS) market, but only two or three companies will ultimately succeed. Amazon, with AWS, has already proven to be a credible player. Google is making quick strides in the Iaas market that Kirjner believes will succeed. Possibly, Microsoft (MSFT) will also succeed, according to the analyst.

About Verizon (VZ), AT&T (T), VMWare (VMW), Hewlett-Packard (HPQ), Centurylink (CTL), BT and Cisco's (CSCO) efforts to enter IaaS, Kirjner said "we have very little doubt that they do not have the right computer science and engineering skills and assets to compete with Amazon, Google, and Microsoft."

Currently, the analyst estimates AWS's 2013 revenues were in excess of $3 billion, growing more than 85% from 2012 levels, while Google Compute Engine earned $100 million or less in revenue. "Microsoft, probably booked a few hundred millions in infrastructure-as-a-service revenues in 2013 as part of Azure, certainly a figure that is much closer to Google Compute Engine's revenues than to AWS's," Kirjner wrote.

Those figures suggest AWS may have a 70%-to-75% market share in the IaaS market. Even if the competition has a 25% market share, Kirjner believes in-process projects at the likes of Amazon, Google and Microsoft may make the gap even larger.

"We believe that in addition to Amazon, only Google and Microsoft have a real shot at being at scale IaaS providers. IBM also cannot be dismissed, but it is not clear to us they have the right experience and expertise, even after the acquisition of Softlayer, or the economic incentives to push public cloud services aggressive," Kirjner wrote.

Price Cuts, Moore's Law

In March, Google said it would cut pricing for Google Computer Engine by 32%, surprising some analysts and business users. Kirjner believes the price cuts have only begun between Google and Amazon, potentially making it prohibitively risky for those seeking to enter the market. "This is just the very beginning of Google's journey to build a competitor to AWS," Kirjner said.

Potential future price cuts may leave some tech heavyweights on the sidelines, but there is reason to believe IaaS will be a profitable endeavor for Amazon, Google and Microsoft. Kirjner believes the steady-state operating margins of IaaS businesses at Amazon and Google can exceed 25% and that return on invested capital can exceed 20%.

The key is that for IaaS providers that operate at scale, price cuts may not outrun expense reductions as cloud computing power increases. "The saving grace for the cloud providers is that the vast majority of their COGS, including server and infrastructure depreciation, as well as power consumed, scale with Moore's Law and also decline 20% 30% per year, so their gross margins will remain the same if they cut prices at that rate," Kirjner wrote.

If AWS and Google Computer Engine operate at a very high server utilization, they can turn IaaS to a profitable endeavor. "[We] think the public cloud business works at scale because AWS and possibly Google Compute Engine will be able to operate at very high server utilization; high enough to drive gross profits on a per server basis and at a large enough scale to offset the fixed costs (R&D and G&A)," Kirjner wrote.

If Google's war with Apple in the mobile device market (by way of Android) and Amazon's increasing threat to retailers as large as Wal-Mart (WMT) and Target (TGT) get the most press, it is a brewing combination between the two burgeoning cloud computing powerhouses where a next fight in Silicon Valley may quietly take hold.

-- Written by Antoine Gara in New York

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