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Investing: Is there sunshine ahead for cloud computing?

Technology investors have their heads in the cloud these days.

Cloud computing, which supplies on-demand hosted services over the Internet, requires only that its clients have a computer and Internet access. It handles the functions traditionally performed by a firm’s in-house hardware and software.

The global cloud-computing market is expected to reach $241 billion in 2020, up from $41 billion in 2010, according to Forrester Research. That long-term potential is reflected in the highflying stocks of companies actively involved in the concept.

A stumbling block, however, is concern over the security of data when a client firm can no longer control it on its own premises. Hackers and crashed systems are, after all, among a company’s worst nightmares.

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And while the cloud is a definite boon to smaller firms, more established companies have already made significant investments in equipment and staffing. There is also confusion over what cloud computing really is and who provides it.

The field’s successful pioneer is Salesforce.com Inc., a well-managed company that over the last decade effectively introduced this cost-saving business model. It offered a monthly subscription service that allowed firms to simply go to their Web browsers, point to salesforce.com and begin using it. That turned out to be a good financial deal for its clients as well as for its shareholders.

Continuing to add applications as it also improves its existing service to nearly 100,000 clients, Salesforce.com has potential to significantly increase international revenues. Although its early start and brand recognition have made it the vendor of choice for firms looking to cut IT costs, future competition is expected to intensify.

“Cloud computing lets a company build scale very quickly without a lot of capital investment and maintenance costs, because you don’t need an entire information technology department,” said Ryan Issakainen, exchange-traded fund strategist with First Trust Advisors in Wheaton, Ill. “It makes it possible to build a more ‘a la carte’ data solution for a business.”

His firm’s new First Trust ISE Cloud Computing ETF has a stock portfolio of 40 companies, some of which might be considered risky as individual stock purchases. More than half of its holdings are “pure play” cloud computing firms, with the remainder being large technology conglomerates or cloud “enabler” firms providing support and software.

Examples of strong-performing pure plays in the portfolio include:

• Aruba Networks Inc., a provider of wireless networking equipment for large, sprawling organizations that permits secure access for employees wherever they work or roam. Its 14,000 customers include government, industry and universities. With its high profit margins and growth prospects, it could become a takeover target.

• TIBCO Software Inc., a software company focused on service-oriented tools such as business process management, is noted for strong technology, innovative new products and customer relationships. It has made key acquisitions and could be attractive as a candidate for an acquisition.

• Teradata C, which provides data warehousing and analytics for global organizations through bundled software and hardware, was spun off from NCR Corp. in 2007. Its clients tend to have high IT budgets. It should benefit from growth in data volume and continued expansion of its sales territories, though it does face rivals with deeper financial pockets.

“While the topic of cloud computing is not new, there still is a lot of confusion in the market because so many things called cloud computing really are not cloud computing at all,” cautioned Holger Kisker, principal analyst with Forrester Research in Boston. “A number of vendors call everything ‘cloud,’ and we would call this ‘cloud washing.’ ”

Old-line, cash-rich technology giants that effectively incorporate the cloud concept will play a significant role and profit from it as well.

While the cloud threatens the desktop-based Office franchise of Microsoft Corp., the company’s Azure cloud computing platform should help customers easily make the transition into this new technology, he said. Microsoft made an early and earnest move that is expected to provide high returns on invested capital while it still profits from current products.

Kisker expects Google Inc. and Amazon.com Inc., among other tech mainstays, to be strong players in the cloud. Issakainen would add Apple Inc. and expects there will be others as well.

Experts say it is important to differentiate between the two distinct types of cloud.

“The ‘private’ cloud is the new term now being used for existing enterprise data centers,” said Sunit Gogia, senior equity analyst with Morningstar Inc. in Chicago. “But what most people are really thinking of is the ‘public’ cloud, which is when a company uses a third-party provider for cloud computing’s shared resources, such as infrastructure and shared management.”

Issakainen, Kisker and Gogia all admire the success and stock potential of Salesforce.com because it provides applications to small businesses that were unable to afford them before. It turned total “non-consumers” of a service into consumers.

“It takes some time to get used to having data being outside of a company’s control,” Gogia said. “But I do think that this model will gain more traction with larger enterprises over time.”

In the long run, the money-saving aspect of cloud computing will spur its growth and provide profits for investors — so long as security issues can be addressed.

Andrew Leckey answers questions only through the column. Write to him at yourmoney@tribune.com.


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