Is the Cloud Recession-Proof?

Two weeks into the first Wall Street earnings season that includes COVID-19 data, most big tech companies that operate a large cloud unit have reported results. Judging from the growth rate and revenue numbers alone, the cloud seems to be weathering the coronavirus storm just fine. AWS grew 33% year-over-year and hit the $10 billion USD quarterly revenue mark for the first time. Azure grew by 59%, Google Cloud (includes both GCP and GSuite) grew by 52%, and IBM’s Cloud & Data Platforms category (includes Red Hat) grew by 32%. Other major players like Alibaba and Oracle have yet to report their earnings.

But as a full-fledged industry, the cloud is relatively new, even though cloud computing as a form factor and product has been around for more than two decades now. Loudcloud (later Opsware) and Rackspace were both founded before the dot com boom busted. AWS was launched in 2006 with S3, SQS (Simple Queue Service), and EC2.

The current COVID-19-induced recession, if not depression, will be the first time the cloud computing industry is a meaningful participant of a large-scale economic downturn.

So given its current, uninterrupted growth trajectory, is the cloud recession-proof?

(NOTE: in this post, “cloud” means either infrastructure or platform-as-a-service, IaaS or PaaS. It does not include cloud-based SaaS products, where there are too many types and variations.)

Definitions and Framework

Before we dive into the analysis, let’s establish some common definitions and a framework first.

What makes a business or industry recession-proof?

Wall Street's somewhat technical financial definition is anything that has a negative beta. In plain terms, it means any security whose price movement is opposite of the stock market’s; if the market goes up, that security goes down, and vice-versa. Gold and U.S. Treasury bonds are the classic examples. Bitcoin is the more edgy, less understood example.

There’s also a more Main Street way to think about what is recession-proof. It’s anything that people must spend money on, regardless of how bad the economy is and how bad their personal financial situation is. Typically, that means things like utilities (electricity and water), car insurance, and essential consumer products like food and toothpaste.

Of course, these are all heuristics that do not reflect reality completely. One common heuristic is that alcohol consumption is recession-proof. (You’d want to get drunk when things are good and when things are bad.) However, certain academic study has shown that alcohol consumption actually decreased during the 2008 Great Recession.

So how should we evaluate the cloud’s recession-proof-ness? Investopedia’s five characteristics of a recession-resistant company seems to be a reasonable framework for this exercise, if we imagine each cloud platform to be an independent company. You are a recession-resistant company, if you have one of the following characteristics:

• provides critical repair services
• sells consumer essentials
• serves customers insulated from downturns
• provides mandated products or services
• sells proprietary or specialized products

Let’s see if a cloud platform would have one or more of these characteristics.

Provides Critical Repair Services?

Not really. If anything, cloud platforms are more the consumer of these critical repair services. Given the increasing criticality of the cloud infrastructure to the essential functions of our society, the businesses that do serve the cloud infrastructure, e.g. server and network maintenance, physical security of data centers, etc., may be more recession proof than the cloud itself. Regardless of which cloud is more in demand, and even if the whole industry experiences a categorical downturn, the services that keep them in shape and functioning can’t stop.

Sells Consumer Essentials?

No. Certain cloud vendors may be the infrastructure that support the stores that do sell consumer essentials. Obviously, AWS itself is now the foundation to Amazon.com that is selling and delivering many of the consumer essentials. But most consumers don’t know, or care, if their essential shopping is happening in the cloud or not. And in an apocalyptic scenario where the entire Internet economy collapses, people will adapt and buy essential goods from brick and mortar options.

Serves Customers Insulated from Downturns?

Probably yes. The customer base of the cloud is broad and diverse, from startups, to larger enterprises from all industries, to governments of all levels and sizes. While some of those customers will suffer during a recession, others will be more in demand for different reasons. Projecting into the future of our current recession, travel companies and airlines won’t be using as much cloud, but Zoom, Slack, and other products used for remote work will use more. Many startups and SMBs will shutter, but healthcare providers, vaccine research, and certain government services like unemployment insurance applications will need more capacity than ever before. The shift may not be completely proportional, but continuous consumption of cloud resources is the constant.

Provides Mandated Products and Services?

Not really. Using the cloud may be a good idea for many businesses, but it’s not border or custom control, financial audits of public companies, or oil pipelines inspection. This category of recession proof services are typically attached to specific laws or regulations that require they happen regularly, no matter what’s happening to the economy. Using the cloud is a business choice, by no means a requirement or mandate.

Sells Proprietary or Specialized Products

Quite possibly. This is a tricky one. What happens on a cloud platform is powered by a mixture of open source and proprietary technology. Some of the data center designs are open sourced as a part of the Open Compute Project. Most of the hardwares is acquired from vendors selling proprietary technologies. Most of the fundamental software components are open sourced at their core, but tied together with proprietary code that works differently in one cloud versus another. The core value that a cloud delivers for its customers is multi-dimensional: some technological, some operational, some financial, and each dimension plays out differently in a recession. So is the cloud, as a product, proprietary or specialized enough that its customers would maintain, if not increase, its spending on it during a downturn? Quite possibly.

Not Satisfying? I Agree

If you don’t find this analysis satisfying, you are not alone. I don't either. (And if you came to this post looking for recession proof stock picks, I’m sorry to disappoint you.) There isn’t an established category of recession proof businesses that fully captures all dimensions of the cloud industry.

The cloud is part utilities, part commercial real estate, part railroad, and part something new that warrants its own framework. (I welcome your input to develop a better analytical framework together.)

There are also few data points that can help us understand and model how cloud platforms will perform during a recession. This COVID-19 recession will be the first one.

Lastly, even if we do have a framework and enough information to establish that cloud platforms are indeed recession proof, it’s hard to invest in them in a targeted way. All the big cloud vendors are parts of bigger tech conglomerates. And the financials around their cloud units are inconsistent and convoluted -- Microsoft, Google, IBM, Oracle all have their own definition and “spin” on what should be considered “cloud”, which is a point of frustration I’ve written about many times before.

Until Amazon decides to break AWS away into a separate entity, or when a cloud startup like Digital Ocean eventually go public, just investing in cloud computing platforms in the public market is difficult. The best you can do is invest in one of the big tech companies with a cloud or a data center colocation company like Equinix.

All the dissatisfactions aside, how the entire cloud industry will fare during this current crisis is worth watching and learning from, if only to prepare for the next recession. And there will be another recession.

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