Much has been made of the moderate slowdown that Amazon (AMZN) Web Services (AWS) has seen in its growth rates, but those dwelling on this are arguably missing the big picture.
Namely, that total corporate spending on public cloud infrastructures (AWS included) is still growing very strongly, and is cannibalizing demand for traditional enterprise hardware systems along the way.
Though cloud adoption isn't the only near-term headwind it's facing -- trade tensions and the macro uncertainty caused by them aren't helping either -- enterprise storage giant NetApp (NTAP) appears to have provided the latest sign that cloud cannibalization isn't letting up. On Thursday afternoon, the company warned that it expects to report July quarter revenue of $1.22 billion to $1.23 billion, soundly below prior guidance of $1.315 billion to $1.465 billion and implying a 17% annual drop. NetApp also said it now expects its fiscal 2020 (ends in April 2020) revenue to be down 5% to 10%, after having previously forecast it would grow "at the low end" of a mid-single digit range.
NetApp's shares fell 20% in response to the warning, and sparked a broader selloff in both enterprise hardware firms and -- though the direct impact of weak hardware demand on their sales is less pronounced -- infrastructure software providers. Dell Technologies (DELL) fell more than 9%; Nutanix (NTNX) , Pure Storage (PSTG) and VMware (VMW) all fell sharply; and HP Enterprise (HPE) and Splunk (SPLK) both slumped more than 6%.
The warning arrived about a week after Intel (INTC) reported that its Data Center Group (DCG), whose revenue is dominated by sales of Intel's Xeon server CPUs, saw its sales to enterprise and government clients drop 31% annually in Q2, as difficult annual comparisons, soft demand (particularly in China) and inventory-clearing efforts by hardware OEMs all weighed. On Intel's earnings call, CEO Bob Swan said that Intel believes the enterprise/government spending environment "won't get dramatically better" during the second half of the year.
Others have also reported seeing soft enterprise hardware demand. With the qualifier that cyclical trends in its mainframe business also weighed, IBM (IBM) reported its Systems segment revenue fell 23% annually in Q2 (a little worse than expected), with a 41% drop in mainframe sales and a 21% drop in storage sales overshadowing a 3% increase in Power server sales. And earlier this week, memory giant SK Hynix noted soft demand from enterprise server makers is weighing on its DRAM sales.
Meanwhile, though its growth slowed a bit from Q1's 41%, Amazon Web Services (AWS) still reported its Q2 revenue rose 37% to $8.38 billion. Microsoft's Azure platform saw 64% June quarter growth (no revenue figure was shared), with the software giant indicating growth was stronger for Azure's cloud infrastructure (IaaS) and developer platform (PaaS) services. And Google disclosed that its "cloud" revenue, which covers both the Google Cloud Platform (GCP) and G Suite app subscriptions, hit an $8 billion annual revenue run rate in Q2 -- twice the run rate it was on as of Q4 2017.
Also, while the cloud giants have slowed their spending on chips and hardware in recent quarters as they digest existing capacity, it looks as if spending is beginning to improve. Intel, which saw DCG's sales to cloud service providers drop 1% in Q2, said it expects stronger cloud demand during the second half of the year. Likewise, Samsung, the world's biggest memory maker, noted data center clients "started to resume purchasing" late in Q2, and sees the trend continuing. Hard drive giant Seagate (STX) and data center switch supplier Arista Networks (ANET) are also forecasting improved cloud orders, although Arista qualified its remarks by saying that it doesn't expect cloud growth to match the very high levels seen during the second half of 2018.
It's not hard to see the broader trend. While the enterprise server and storage markets are still massive, and will remain that way for a long time, public cloud adoption keeps eating into demand with each passing year, as prices for cloud services continue dropping and the various advantages provided by public clouds (big ones include less operational overhead, faster app/service deployment times and access to cutting-edge technologies) lead businesses to both deploy many of their new workloads on public clouds and migrate some of their existing workloads to them.
For some chip and hardware suppliers, growing sales to cloud giants should more than offset any impact they see from weakening enterprise hardware spend. And in the case of a company like NetApp, rising sales of software used to manage cloud infrastructure assets could partly offset lower hardware demand.
But considering the extent to which the cloud giants rely on servers and storage based on their own designs, the continued growth of AWS and its peers is clearly going to remain a problem for many suppliers of traditional enterprise servers and storage systems.
