Cloud Computing Looking Ominous for 2014

NEW YORK (TheStreet) -- The key technology trend of the last few years has been the barbell effect. The two edges of the market have grown, and the center has narrowed.

The computing "middle class" of PCs and servers are being rendered obsolete, on the one hand by cheap mobile devices like phones and tablets, on the other by scaled cloud environments.

Companies that lived in that market center -- like Hewlett-Packard (HPQ), Microsoft (MSFT), Oracle (ORCL) and IBM (IBM) -- have been hard-pressed to scramble out of the way of device and cloud giants like Apple (AAPL), Google (GOOG) and Amazon (AMZN).

I've written about IBM's problem recently. And the problem is not going away; if anything, it's getting worse. While 2013 was a year of struggle for Big Blue, 2014 will be its annus horribilis. The company that emerges from the struggle will be far, far different from the one that went into it.

But none of this is a secret. Technology investment is about the next trend.

And the next trend is consolidation within the cloud.

We are already starting to see it. Companies like RightScale, created to arbitrage and manage competing cloud services, are laying off workers because there just aren't that many good choices. Rackspace (RAX), the OpenStack hosting company valued at $76.31 per share at the start of 2013, has sunk to $37.21 as of the market close on Jan. 28.

If there are fewer viable cloud companies, then there are fewer viable merchants to the cloud. Software companies like CA (CA) and even Red Hat (RHT) should have a hard time. Seagate (STX) and Western Digital (WDC), which supply hard drives, are starting to roll over to the downside.

Big gains are getting harder to find in tech as more companies avoid the public markets altogether. DeepMind won repeated rounds of venture funding and was bought this week by Google for $400 million. The same thing happened last year with Tumblr, bought from private investors by Yahoo! (YHOO) for $1.1 billion.

Between crowdfunding and the private equity buy-ins made possible by the JOBS Act on the one hand, and the hunger for leading-edge acquisitions by companies like Google on the other, the public market is getting shut out of the big tech gains of yesterday.

The problem with buying into the big boys, meanwhile, is the law of big numbers. As numbers get larger, it gets harder to grow them. At some point growth slows down and investors demand profits, then dividends. Even the best-run companies, like Apple, become "extractive," sources of cash rather than users of capital. Society doesn't stink, there's just a limit to big.

The reason for Google's acquisition spree is that it fears becoming that kind of company. To maintain the momentum of its $50 billion in revenue in 2012, Google needs total 2013 revenue of well over $60 billion. Through the first three quarters of 2013 it had revenues of about $39 billion, as opposed to $33 billion in the first three quarters of 2012. Google reports earnings this week.

Amazon faces the same problem. It had 2011 sales of $48 billion, 2012 sales of $61 billion. Through the first three quarters of this year it had done almost $49 billion.

That means it needs well over $20 billion in fourth quarter sales to maintain the stock's momentum, assuming that, as usual, it refuses to show a profit. The mean estimate for those sales is $26 billion. Beat that and the stock rises, fall well short and it falls.

Between Google and Amazon, I think Amazon is more likely to keep growing its top line because so much of what it sells are physical goods rather than virtual ones. Sure, Amazon's aura is based on its cloud dominance, but the absolute dollars in cloud aren't as big as they are in real products.

Physical goods also do a better job of maintaining their price than virtual goods. At its present size Amazon still trails the large brick-and-mortar retailers like Costco (COST) and Kroger (KR) in revenue -- Wal-Mart (WMT) is still four times larger.

Assuming Amazon meets expectations for the Christmas quarter, there's nothing to stop the company from further gains.

I'm surprised to write that, because I personally sold out of my own Amazon shares back when they were at $230. They were $394.43 at close on Jan. 28. Can they make it to $600, $700, $800 per share this year? That could mean a market cap of $366 billion, a number rapidly approaching Apple's $452 billion.

It's possible, but the law of large numbers will eventually beat Amazon, too. This may be your last year to speculate on Amazon as a fast-moving growth stock. At some point it has to start making money, because the bigger numbers get the harder they are to grow.

Apple learned that lesson, over on the device end of the barbell. Amazon will too.

At the time of publication, the author held AAPL and GOOG.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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