Three months after signs began emerging that capital spending by cloud giants on hardware and chips is poised to improve following an early-2019 slowdown, this earnings season has yielded a lot of evidence that such spending is now rebounding meaningfully.
At the same time, comments from Intel (INTC) - Get Intel Corporation Report and Amazon.com (AMZN) - Get Amazon.com Inc. Report give reasons to think that the current cloud capex surge won’t be as massive on a percentage basis as the one seen in 2017 and 2018.
Here’s a run-down of what a few Internet/cloud giants (the proverbial hyperscalers) have shared over the last two weeks about their near-term capex plans.
- Microsoft (MSFT) - Get Microsoft Corporation Report forecast that its capex will grow during its March quarter relative to a December quarter level of $4.5 billion (up 17% annually).
- Facebook (FB) - Get Meta Platforms Inc. Report reiterated that it expects to spend $17 billion to $19 billion on capex in 2020. That’s up from 2019 capex of $15.7 billion and 2018 capex of $13.9 billion.
- Alphabet (GOOGL) - Get Alphabet Inc. Report said it plans to up its capital spending on both “technical infrastructure” and office facilities in 2020. And notably, the company forecast that relative to 2019, a greater portion of its technical infrastructure spend will involve servers as opposed to data center construction.
In addition, Intel reported that its Data Center Group (DCG), which covers sales of server CPUs and certain complementary products, saw its sales to cloud service providers grow 48% annually in Q4, after growing a modest 3% in Q3 and dropping 1% in Q2. Intel also forecast that strong cloud demand would lead its “data-centric businesses” (a term used to collectively describe DCG and several other units) to grow more than 25% annually in Q1.
Some other chip and component suppliers, such as memory giants Samsung and SK Hynix and hard drive and flash memory giant Western Digital (WDC) - Get Western Digital Corporation Report, have also signaled this earnings season that sales to cloud clients are on the upswing. On its call, Western indicated that it expects cloud demand to remain strong through the first half of 2020.
However, while Intel forecast it would see strong cloud demand this quarter, the company also said that it expects “more modest” cloud capacity expansion during the rest of 2020, as cloud providers “move to a digestion phase.” That suggests the current cloud capex up-cycle will be briefer than the last one -- even if some suppliers see demand remaining strong beyond Q1.
The fact that the hyperscalers (aided by their top-notch engineering talent) have steadily become more efficient when it comes to the use of their data center resources appears to be helping them keep their data center capex from growing too quickly.
Here, Amazon’s Q4 earnings call comments are noteworthy. On the call, CFO Brian Olsavsky said that Amazon now plans to depreciate the value of capital investments in servers over four years, rather than three as it has historically done. He added that Amazon has found that the useful life of its servers is now exceeding four years, thanks to the work it has put in to make its servers last longer.
“We've been operating at scale for over 13 years in this business and continue to refine our software to run more efficiently on [our] hardware,” Olsavsky said. “[This] lowers stress and extends the useful life both [for] servers that we use in the AWS business and also the servers that we use to support our own Amazon businesses,” he said.
Microsoft has also mentioned at times that it’s seeing efficiency gains for its data center capex. And Google and Facebook aren’t exactly slouches in this department either.
The fact that the hyperscalers are spending more efficiently doesn’t mean that their capex is going to be declining over the long run. The computing, storage and networking needs of many web and cloud workloads -- everything from cloud infrastructure and online video services, to AI training systems and AI-powered voice assistants, to search and news feed algorithms -- look poised to continue seeing healthy growth in the coming years.
Moreover, unlike telcos that are nervous about spending more on capex because they’re struggling to see revenue growth, the hyperscalers are still growing revenue at healthy double-digit annual clips and (both when it comes to data centers and other investment areas) have collectively shown a willingness to sacrifice near-term profits in the name of pursuing long-term bets.
But with that said, investors in companies supplying chips or hardware to the hyperscalers should keep in mind that these companies are proving to be much more efficient at using their hardware than the typical Global 2000 enterprise. This could result in cloud capex simply growing at a decent clip over the long run, rather than the sky-high rates seen for a while in 2017 and 2018.
Alphabet, Amazon, Microsoft and Facebook are holdings in Jim Cramer's Action Alerts PLUS member club.