This column originally appeared on April 4 on Real Money, our premium site for active traders. Click here to get great columns like this.
While the steady migration in IT spending dollars towards public cloud infrastructures has become a major headache for traditional enterprise IT giants such as IBM (IBM) , HP Enterprise (HPE) and Dell EMC, it has been a boon for select chip, component and networking hardware firms servicing the cloud giants' ever-growing needs. But as the latter group's cloud sales have swelled, supply shortages and rationing have become a common occurrence.
Those shortages provide some context to a report that Amazon.com (AMZN) and Alphabet/Google (GOOGL) have joined the ranks of firms interested in Toshiba's (TOSYY) massive NAND flash memory unit. While it's unlikely that either company wants to own the business outright, a "strategic" investment could make sense at the right price. And it could also be a sign of things to come.
In the latest in a flurry of reports about Toshiba's attempts to unload its flash business, Japan's Yomiuri Shimbun reported Amazon and Google have taken part in the bidding process for the business, which analysts have estimated is worth $15 billion or more. "About 10 companies" are said to have taken part in the bidding to date.
The report follows one stating Apple (AAPL) and Broadcom (AVGO) are interested parties. Other rumored suitors include Western Digital (WDC) , whose SanDisk unit has a major flash manufacturing JV with Toshiba, along with South Korea's SK Hynix, Taiwan's Foxconn and private-equity firms Silver Lake and Bain Capital. Should the unit sell to a non-Japanese firm, as seems likely, the Japanese government reportedly prefers the buyer to be American, owing to national security worries.
It's worth remembering here that Yomiuri Shimbun's sources, along with those of other Japanese publications reporting on the sale process, are likely close to Toshiba, if not inside the company. Such sources naturally have an incentive to talk up the amount of interest shown in the business, in hopes of getting suitors to up their offers.
Also: While Amazon and Google's flash needs are large and growing, it's quite unlikely that either company (unlike Apple) could single-handedly consume all of the flash currently sold by Toshiba, or come close to doing so. Toshiba has been estimated to control about a fifth of a NAND market worth about $35 billion, and expected to see strong growth this year.
Thus in the event that Amazon and Google are eying Toshiba's flash business, it's likely to buy a minority stake. One that would let the companies guarantee a stable supply of NAND in the coming years, and the chance to procure it at reasonable prices via long-term contracts.
Between their massive data center buildouts -- done to support their cloud infrastructure businesses, as well as consumer services such as YouTube, Prime Video and Google Search -- and the steady cannibalization of hard drives by solid-state drives (SSDs), it's a safe bet that the amount of NAND used by Amazon and Google within their servers and storage systems will rise substantially over the next several years. Both Amazon Web Services (AWS) and the Google Cloud Platform (GCP) now provide clients with a number of computing instances that feature high-speed SSDs. Major production ramps for cheap/dense 3D NAND flash should help SSDs take additional share from hard drives in the coming years.
Each company is also buying a growing amount of NAND for use in consumer hardware. Amazon for its tablets, e-readers and streaming set-tops, Google for its Pixel phones. But compared with say, an Apple or Samsung, Amazon and Google's consumer flash needs are still fairly modest.
Recent NAND shortages might have something to do with Amazon and Google's reported interest in the Toshiba unit. The shortages originally stemmed from Apple's doubling of iPhone storage capacities across price tiers last September, and have continued due to strong demand from both the smartphone and SSD markets. A stake of, say, 10% or 15% in Toshiba's unit would help Amazon and Google guarantee that they get first priority for Toshiba's output when future shortages happen.
But NAND isn't the only product heavily consumed by cloud giants that's seeing shortages. Certain optical components are also in short supply, as demand for 100-gig parts used within switches and (increasingly) servers surges. Component vendor NeoPhotonics (NPTN) and switch vendor Arista Networks (ANET) are among those to report of 100-gig shortages.
Would it make sense for Amazon or Google -- or for that matter, Facebook (FB) or Microsoft (MSFT) -- to take a stake in an optical component vendor like NeoPhotonics or Finisar (FNSR) ? Maybe. The business is less commoditized than NAND, and so buyers have an incentive to keep their supplier options open. But if a cloud giant does have a major long-term relationship with a component firm, it could make sense to buy a stake to guarantee supplies, finance manufacturing ramps and drive R&D investments in products the company wants to see developed.
For some mixture of the aforementioned reasons, investments could also be made in other suppliers. Possibilities include DRAM makers, providers of data center colocation capacity and the Asian contract manufacturers responsible for producing much of the hardware companies like Amazon and Google put into their data centers.
Making such investments in key suppliers is hardly unusual for tech giants. Apple has long helped finance the capital investments of major iPhone suppliers, and Intel and other chip manufacturers have taken stakes in chip equipment makers to help pay for R&D investments.
Five years ago, it would have made little sense for the top cloud data center owners to do the same. But in an era where Google spent $10.2 billion on capex last year and Facebook has forecast it will spend $7 billion to $7.5 billion this year, the logic is much stronger. And we might now be seeing the first signs of the cloud providers buying into it, as they come to grips with just how much spending clout they've come to wield.