Cloud computing: raining money

September 20, 2010: 3:00 AM ET

Tech titans are battling to pay big bucks for once bland computing firms. Two questions: Are they worth it? And who's next?

When tech titans HP (HPQ) and Dell (DELL) became entangled in a furious back-and-forth bidding war over 3PAR (PAR), they unwittingly introduced much of the public to a decidedly-unsexy area of tech that is becoming indispensable in our increasingly smartphone'd, tabletized, app-driven world : cloud computing.

In fact, HP's $2.4 billion acquisition of the data storage company was just one in a recent spate of acquisitions. Four smaller cloud-related companies have also recently been scooped up by the big boys.

Last month, virtualization software-maker VMware (VMWannounced it would buy Integrien, a provider of network analysis, and TriCipher, a security software developer, for undisclosed amounts. Around the same time, Citrix Systems (CTXS) also bought VMLogix for its cloud management technology and Red Bend Software Inc. snagged VirtualLogix, which allows Intel and ARM-based mobile devices to run multiple operating systems on a virtual machine. (Again, terms were not disclosed.)

Companies like HP and Dell are going full bore on cloud services because they enable outsourcing, usually via the Internet, of scalable and/or virtualized IT services, from data storage, software, to billing and payment. The convenience offered by the cloud is significant: why should a businesses, app developers, banks, startups or even government handle  the headaches and cost of building infrastructure internally when they can be offloaded to cloud services, resulting in increased productivity and cost-savings?

Analysts like Paul Burns, a principal at IT analysis firm Neovise, attributes the recent activity to the relative longevity of cloud and cloud-based services, like Amazon with its EC2 virtualization service, launched in 2006, and Salesforce.com (CRM), founded in 1999.

"It's early in the cloud computing market, so companies think if they move now, maybe things will be a little less expensive in some areas, but if they wait, they not only become more expensive, they risk having a competitor buying that offering instead,"  says Burns.

Is cloud overvalued?

The hype around cloud, plus the general frenzy in the M&A space, could be why we're seeing companies go to war now over companies like 3Par: they're taking risks early in the game in hopes that those bets will pay off later -- both financially and technologically. The goal is what it always is: to be better positioned to profit on the next big thing, as more and more businesses decided to outsource to the cloud.

Analysts Fortune spoke with about the HP/Dell bidding war either wouldn't comment or said it was too early to speculate as to whether HP overpaid, but were willing to discuss some other past cloud deals. And there's one in the space that's just a whopper:

In late 2003, EMC Corporation (EMC) bought virtualization software company VMWare for $635 million, a large sum that in hindsight turned out to be a pittance: in 2007 EMC later spun off part VMWare to unlock shareholder value and retain talent. The company's market cap is now approximately $34 billion. As EMC still owns 80% of the firm, and VMWare's software remains the foundation for the majority of cloud computing services that require some form of virtualization. Any big company picking up a cloud firm today has to be hoping for a similar outcome.

In fact, 3PAR wasn't the first cloud acquisition for HP. In July 2007, it picked up Opsware, a data center automation start-up for $1.6 billion, or 16 times Opsware's 2006 revenue. In that respect, HP overpaid. The Wall Street Journal recently questioned whether valuation even matters  in the cloud sector right now, citing an analysis by the ISI Group which reported that over the last five years, HP typically paid 1.9 times a company's 12-month revenue in hardware and networking acquisition.

(Unfortunately the growth of Opsware under HP can't be broken out, since the company was subsumed into HP's overall software business. However in the three years since, according to Burns, the HP software business segment that Opsware became a part of has totaled just $1.366 billion in earnings, significantly less than the $1.6 billion price for Opsware alone.)

So, cloud acquisitions or investments are not winning lottery tickets: execution and integration are everything. Opsware was famously troubled as a standalone company. A nice exit for shareholders and new ownership doesn't magically change that, or any company's prospects.

Three clouds properties ready to burst

Burns and Gartner analyst David Smith identified three companies that could bring the rain to any company rich enough to snap them up, and wise enough to run them well:

1) Zuora -- the Salesforce.com of subscription-based payment and billing.

Many subscription based businesses still rely on costly and complex in-house billing systems, but Zuora offers cloud based payment and billing services for subscription-based businesses, new and old. CEO Tien Tzuo spent nine years at SalesForce.com – he built SalesForce.com's original system and served in several roles including Chief Marketing Officer and Chief Strategy Officer. Backed by WebEx and SalesForce.com founder Marc Benioff, Zuora reportedly signed over $1 billion in contracted subscription revenue during the first quarter of its fiscal year and experienced 102% in revenue growth.

2) Nimbula -- The private cloud company with big name backers.

Nimbula emerged from stealth mode last June and is most notable for its pedigree: The same team that built Amazon's EC2, former execs Chris Pinkham and Willem van Biljon, are behind Nimbula. Pinkham and van Biljon's industry cred has attracted some pretty high-profile VCs, including Accel Partners which has also invested in AdMob, Facebook and ComScore, and the legendary Sequoia Capital. So far, Nimbula has raised more than $20 million in two rounds of funding.

3) Heroku -- Building an application platform on the cloud.

Started in 2008, the San Francisco-based cloud provider focuses on "platform as a service," a concept popularized by SalesForce.com, that emphasizes ease of use, automation and reliability for app builders. Heroku employs a multi-tenant software architecture, so one instance of software on a server can serve more than one client company. Third party add-ons let developers easily integrate additional features into their deployed apps. Heroku has received over $13 million in funding to date.

As cloud computing continues to mature, we'll see more mergers and joint ventures, lots of overbidding and maybe even a VMWare level bargain or two. However the sector grows, as Winston Churchill said about an entirely different matter, "this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."

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About This Author
JP Mangalindan
JP Mangalindan
Writer, Fortune

JP Mangalindan is a San Francisco-based writer at Fortune, covering Silicon Valley. Since joining in 2010, he has written on a wide array of topics, from the turnaround of eBay to the evolution of net neutrality. A graduate of Fordham University, Mangalindan has also written for GQ, Popular Science, and Entertainment Weekly.

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