SKYY: The Wait For A Cloud Computing ETF is Over

The first cloud computing ETF has arrived.  On Wednesday (7/6/11), the First Trust ISE Cloud Computing Index Fund (SKYY) was listed for trading on the NASDAQ.  Part of the reason investors had to wait so long is that like its namesake, cloud computing is somewhat amorphous, with no clearly defined boundaries and no GICS industry code.  Additionally, many of the biggest players are not considered “pure plays” in the cloud computing space.

Given these hurdles, the underlying ISE Cloud Computing Index takes what appears to be a very reasonable approach.  First, all eligible securities are classified into one of three business segments.  Next, each segment receives a fixed or quantifiable allocation, and finally, the stocks within each segment are equally weighted.  The resulting breakdown looks like this:

• Technology Conglomerate Cloud Computing Companies: These are the large broad-based companies that indirectly utilize or support the use of cloud computing technology.  This segment receives only a 10% weighting and currently consists of just four companies, each receiving a 2.5% allocation.
• Non Pure Play Cloud Computing Companies: These are the companies that provide goods and services in support of cloud computing.  This segment’s allocation is determined by its relative market capitalization versus the market cap of all three segments.  It currently has about an 11% allocation, with the 13 stocks equally weighted at around 0.8% each.
• Pure Play Cloud Computing Companies: These are the companies that are direct service providers for “the cloud” (network hardware/software, storage, cloud computing services) or companies that deliver goods and services that utilize cloud computing technology.  This segment receives the remainder of the allocation, which is currently about 79%.  It is spread across 23 stocks, with each receiving about a 3.4% weighting at the last rebalancing. 

We’ve been strong proponents of cloud computing.  Aided by a strong bull market, the six cloud computing stocks we named in March of 2009 have climbed an average of 316% (+83.4% annualized) through 7/7/11.

In our January 2010 Cloud Computing: The Next Big Thing In Technology article, we argued that “cloud computing should generate impressive returns for investors in the coming years, even though there isn’t a cloud computing ETF yet.”

For those not familiar with cloud computing, First Trust put together an Investor Guide (pdf) that provides an excellent primer on the subject.  The following excerpts are from the guide:

“The phrase ‘cloud computing’ originates from the cloud symbol used by flow charts and diagrams to symbolize the Internet [services connected via telecommunications], dating back to the 1960s.  Although the image of a cloud to symbolize the Internet is nothing new, cloud computing as a service is still in its infancy.

“According to the National Institute of Standards and Technology, cloud computing is a model for enabling convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction.”

SKYY will have an expense ratio of 0.60% and the industry breakdown comes in at Software 32.5%, Internet Software & Services 22.6%, Communications Equipment 16.8%, Computers & Peripherals 11.2%, Internet & Catalog Retail 7.8%, IT Services 7.1%, and Other 2.1%

The largest of the 40 holdings includes TIBCO Software Inc. (TIBX) 3.8%, Aruba Networks, Inc. (ARUN) 3.8%, Teradata Corporation (TDC) 3.7%, Amazon.com, Inc. (AMZN) 3.6%, Open Text Corporation (OTEX) 3.6%, Netflix Inc. (NFLX) 3.5%, Rackspace Hosting, Inc. (RAX) 3.5%, Salesforce.com, Inc. (CRM) 3.5%, Informatica Corporation (INFA) 3.5%, and F5 Networks, Inc. (FFIV) 3.5%.

Additional information:

• SKYY Summary Page
• SKYY Fact sheet (pdf)
• Prospectus (pdf)
• List of 40 holdings and latest allocations 
• Rightnow Technologies (RNOW): Pick of the Week for 2/18/10 – The Right Play On The Cloud Computing Boom 
• Informatica (INFA): Pick of the Week for 3/11/10 – The Next Cloud Computing Winner 
• Investing in Cloud Computing (published 7/21/10)

Disclosure covering writer, editor, and publisher:  Long NFLX.  No positions in any of the fund companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Investing in Cloud Computing

Savvy tech investors are always looking for the next best thing. They’re not content with buying the Q’s (PowerShares Nasdaq 100 Index: QQQQ). They want the latest breakthrough technology stocks before everyone knows about them – think Twitter or cloud computing.  The latter isn’t new, but it’s been getting more attention over the past few years. Tech investors should continue to pay attention.

We first discussed the cloud computing trend on March 2, 2009. Although we did not officially recommend Salesforce (CRM) we highlighted how Salesforce was using “the cloud” to their advantage. Since then, CRM has grown an astounding 235%! CRM has risen on the strength of their market position and industry trends in cloud computing. In January, we posted a cloud computing follow-up discussing other merits of the technology. It’s time to revisit the cloud.

Large organizations are abandoning boxed software and opting for more agile software that is supported off-site – cloud computing.  According to the National Institute of Standards and Technology, cloud computing incorporates five essential elements:

• On-demand self-service
• Broad network access
• Resource pooling
• Pay-for-use service
• Elastic scale

Providers market the services in three different models: software-as-a-service, platform-as-a-service, and infrastructure-as-a-service. Software-as-a-service (SaaS) delivers a complete single software solution as opposed to a shelf-bought application. A SaaS example for customer relationship management would be Zoho or SalesForce. Platform-as-a-service (PaaS) is more complex. It offers development and middleware hosted by the vendor – and is more expensive for businesses. An example of PaaS would be Google AppEngine or Long Jump. Finally, infrastructure-as-a-service  (IaaS) is the raw infrastructure for things like servers and storage. IaaS is sold by companies like Amazon Web Services and GoGrid.

Morningstar recently joined the cloud computing conversation.  They distinguished the “public cloud” from the “private cloud”. The public cloud relates to applications like Google docs or Yahoo mail. These applications are shared by multiple users. On the other hand, the private cloud relates to enterprise-level solutions like the ones offered by the companies above. These services are usually behind a company firewall and only available to company users.

Businesses are moving towards the private cloud for one primary reason: support. The companies that support these services the best will do well as large companies move their antiquated software into cloud services. That will help marketers of cloud services. We expect even more momentum to build in the cloud computing space. Make sure you get in on the action.

Disclosure covering writer, editor, publisher, and affiliates: Long QQQQ. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

Growth In Technology: Cloud Computing

Scanning the headlines, it’s easy to get discouraged. With stocks approaching 12-year lows, unemployment at 25-year highs, and a President warning of an impending Second Great Depression, it’s not hard to feel a little down. And yet, all is not lost. CNN/Money posted an encouraging article this weekend about six companies that began during tough economic times. From Proctor & Gamble (PG) to FedEx (FDX), these companies started off in a crisis, panic, or Depression, but ultimately persevered to success.

In that vein I offer a similar silver lining. As many companies struggle to remain profitable, some are still doing well. In fact, year-over-year growth continues for one such subsector that suffers from two market-driven biases. For one, it’s technology-based. Many investors still remember the tech crash of the early 2000s. With long-memories, investors are reluctant to take on large positions in technology. Second, the current economic environment skews investors’ outlook to the negative. Sure, growth is possible. But why bet the farm now?

Although I don’t recommend anyone take a second mortgage, I am encouraging you to consider an attractive area of technology: cloud computing. “Cloud” is a metaphor for the internet. And despite hiccups along the way, the internet is still a source of tremendous potential for many decades to come – hence the reason to consider investing in cloud technology.

More specifically, cloud computing encompasses both software-as-a-service (SaaS) and software-as-a-platform applications. It’s where companies buy subscriptions to external servers and software – hence saving the expense of in-house hardware and IT support. Many businesses are moving to such services as the cost of maintaining servers and staff rises. Cloud computing answers the old question: why buy technology that will be obsolete in a few years when you can rent and always be up-to-date?

One of the more successful SaaS applications has been Salesforce (CRM). Their cloud computing interface is Salesforce.com. Their customer relationship software allows businesses to manage customer interactions from an ordinary web browser. Basically, it’s an on-demand application for businesses who don’t want to buy and maintain expensive CRM-software.

As companies look to reduce initial outlay for servers and pare down payrolls, cloud computer services like Salesforce.com will become more compelling. According to research firm Gartner, in 2008 approximately 10% of software application spending by businesses worldwide was provided over the internet (the cloud), a major increase increased over the last decade. I expect this trend to continue for the long term.

Companies that provide these services and the infrastructure to carry them are becoming increasingly attractive. Vendors such as Citrix (CTXS), and VMware (VMW) provide the backbone for cloud computing services, as does a division of Amazon (AMZN).  Other companies supply the user interface: Salesforce (CRM), Netsuite (N), and Google (GOOG). If any of these companies match up with your overall strategy, it might be a good time to consider an investment.