|‘Kubernetes’ Is the Future of Computing. That’s Bad News for One Stock.|
By Tae Kim
Updated Nov. 23, 2019 3:53 pm ET / Original Nov. 22, 2019 5:06 pm ET
Get ready to hear a lot more about Kubernetes. The Greek word for helmsman or pilot, Kubernetes is shaping up to be the next big wave in computing.
To understand the trend, let’s start with the changing dynamics of software in the cloud. Cloud apps increasingly run in aptly-named containers. The containers hold an application, its settings, and other related instructions. The trick is that these containers aren’t tied down to one operating system and can run nearly anywhere—across different servers and clouds. It’s how Google manages to scale Gmail and Google Maps across a billion-plus users.
Alphabet’s (ticker: GOOGL) Google long ago developed software called Borg to orchestrate its in-house containers—spinning them up and down as needed. In 2014, the search giant opted to make a version of Borg open source, calling it Kubernetes. Today, the major cloud providers all offer a Kubernetes option to customers.
This past week, more than 12,000 developers and executives gathered in San Diego at the largest annual Kubernetes conference called KubeCon. That’s up from just 550 attendees four years ago.
The conference goers are all looking for ways to take advantage of Kubernetes and its ability to automatically deploy, manage, and scale software workloads in the cloud. Ultimately, Kubernetes is accelerating the transition away from legacy client-server technology by making cloud-native software development faster and better.
Aparna Sinha, the director of product for Kubernetes at Google, notes that Kubernetes is built by the same team that created Borg. “We are quite confident in its ability and how it enables applications to run more reliably, more efficiently, and more affordably,” Sinha says. “Kubernetes has really taken off.”
Gartner says more than 75% of global companies will run containerized applications by 2022, from less than 30% today.
“As enterprises modernize their infrastructure and adopt a hybrid multicloud strategy, we see Kubernetes and containers rapidly emerging as the standard,” Jason McGee, chief technology officer of IBM Cloud Platform, told Barron’s in an email.
Of course, not every business is likely to benefit from a better cloud. VMware (VMW), a pioneer of virtualization software that allows a local server to run multiple workloads, could be the most at risk.
If Kubernetes accelerates the cloud shift, demand for on-premises software and equipment is likely to slow. This puts VMware’s core business at risk; its vSphere offering dominates the market for on-premises server virtualization software.
To be sure, VMware recognizes Kubernetes’ importance and is trying to catch up with the trend. In August, the company said Kubernetes has become “the largest generational shift in enterprise architecture in a decade.” At the time, it announced an agreement to buy Pivotal Software (PVTL) for $2.7 billion, saying it needed to own and control an end-to-end Kubernetes software platform.
But Wall Street analysts estimate that roughly half of VMware’s business still comes from its original virtualization business. The company says in filings that it will be a significant portion of revenue for the foreseeable future.
Google’s Sinha says the majority of companies she talks to are actively re-architecting their on-premises VMware-based workloads to the cloud. Kubernetes “is a huge threat to [VMware’s] business,” Sinha says. She argues that customers don’t get enough agility from their existing server virtualization setups.
As VMware rolls out its own Kubernetes effort, it faces a difficult reality. Each of the major cloud computing vendors— Amazon.com (AMZN), Microsoft (MSFT), and Google—offer their own Kubernetes offerings without any VMware software.
A recent Morgan Stanley survey of chief information officers showed VMware was one of the vendors most likely to lose market share as companies migrate workloads to the cloud over the next three years.
Citing a quiet period before its earnings report on Nov. 26, VMware declined to comment on its competitive positioning and potential pricing pressure.
A spokesperson said via email, “With our intention to acquire Pivotal, VMware will offer a comprehensive Kubernetes-based portfolio to help customers harness the full potential of Kubernetes and successfully build, run, and manage their applications and multicloud Kubernetes clusters.”
VMware shares are up 21% this year, slightly below the S&P 500’s return. The stock trades at 24 times adjusted earnings estimates for the next 12 months, above its five-year average of about 20 times, according to FactSet.
The current premium may be too rich, given the risk to VMware, as its customers transition to a cloud-native world. Analysts expect VMware to generate annual sales growth of nearly 10% in each of the next two years, but that forecast could be difficult to achieve if VMware’s vSphere sales fade.
History is littered with innovative companies that struggle to transition to the next technology. VMware may be making the right bet with Kubernetes, but its success in the new world is far from assured. If growth slows, its valuation multiple is likely to compress, leading to a significantly lower stock price.