OVH Groupe ($OVH.FP) is a €2 billion Infrastructure-as-a-Service provider delivering public and private cloud products, shared hosting and dedicated server solutions; it also offers domain name registration, telephony services, web hosting plans, and a wide range of cloud solutions to more than 1.6 million customers, composed largely of SMBs as well as the public sector.1
OVH has grown rapidly to become a global provider of dedicated cloud infrastructure, with more than 450,000 physical servers spread across 37 datacentres in four continents. In their own words, it’s “the leading European cloud services provider, uniquely positioned to capitalise on the rapidly growing cloud market”.
However, it’s also a busted IPO: the company listed in October 2021 at a price of €18.50, raising €400 million at a first day valuation of €3.5 billion. Despite the still going euphoria at the time, the market reaction was far from enthusiastic: the offer was only 1.8x oversubscribed, the price briefly touched €25 but today it’s in the €10 range.2
Founded in 1999 by Octave Klaba as one of Europe’s first internet hosting companies, it grew rapidly from its base in France, systematically reinvesting profits to expand and stay independent: to meet the needs of more and more international customers, new offices were opened in Poland, Spain, Germany, Italy, Portugal, UK, the Netherlands and Ireland. In 2010 the company started to diversify from its original business, entering into the world of cloud, first with a Hosted Private Cloud and later with Public Cloud offers. In 2012, it opened offices and a datacentre in North America.
In order to meet the growing global demand for cloud infrastructure, in 2016 OVH finalised a partnership with KKR and TowerBrook Capital Partners, which acquired a 20% minority stake for €250 million (at an implied post-money valuation of €1.25 billion), with the Klaba family retaining the remaining shares. After selling some shares at the IPO, today the two asset managers still hold a 7.6% stake each, while the Klaba family has ~69%: including employees and executives shares, this leaves only around 15% as free float.
The current offering
Cloud computing provides on-demand, fully automated access, via the internet, to computing, storage and networking resources. Cloud resources may be shared between several customers (public cloud) or dedicated to a single customer (private cloud); they can be operated and maintained at a company’s own facilities (“on-premises”), or they can be outsourced to cloud service providers such as OVH.
Cloud computing encompasses a range of services that include providing access to infrastructure (Infrastructure-as-a-Service or “IaaS”), selecting and operating platforms such as operating systems, virtualisation stacks and security systems (Platform-as-a-Service or “PaaS”) and offering applications that are developed and can function on cloud platforms (Software-as-a-Service or “SaaS”).
OVH provides multi-cloud and hybrid cloud strategies via three main offerings:
1. Private Cloud Services (62% of FY2022 revenues)
Baremetal Cloud (49% of revenues): a high-performance solution where customers have fully automated access to dedicated physical servers on which they operate and manage all software layers, including the operating system and the virtualisation stack (which allows a single server to operate multiple “virtual machines”). It’s a similar experience to having on-premise solutions while at the same time taking advantage of the benefits offered by outsourcing. Customers pay monthly fees that depend on the performance levels they select, for example additional services such as server customisation or data backup. The main uses of Baremetal Cloud services include the computation of complex data, streaming, online gaming and critical business applications such as ERP and CRM.
Hosted Private Cloud (13% of revenues): fully automated, dedicated servers but with the operating system and the virtualisation stack selected and managed by OVH through two offerings: Essential (an entry-level package for small and medium enterprises) and Premier (a high-end package that includes a broader range of services, 24/7 support and tailored security certifications). The main usages for these services include deployment in hybrid cloud strategies, media encoding, big data analytics and disaster recovery, as well as the storage and processing of sensitive data in key sectors such as healthcare, finance and the public sector.
2. Public Cloud Services (16% of revenues): computing and storage services offered on shared servers, providing the greatest degree of scalability and continuity: typically used for processing applications with significant demand bursts and peak loads, such as e-commerce and applications with very large requirements (mass-consumption video and music streaming), as well as non-critical workloads such as testing and application development. The use of these standard platforms provides customers with easy data transfer capability and access to source code, facilitating reversibility and eliminating “vendor lock-in”: this feature is particularly attractive for customers looking to deploy multi-cloud strategies. Customers pay usage fees based on the capacity consumed.
3. Web Cloud Services (22% of revenues): hosting and domain registration, telecommunications and internet access, as well as a “marketplace” of third-party software solutions. Web cloud customers generally pay fixed monthly fees for these services, plus fees for additional services such as support. Main customers in this segment are small and medium-sized businesses, generally seeking secure and reliable web and communications services, to establish their web presence, and to digitise business functions. This is OVH historical business and provides a substantial and recurring revenue base (quite stable, but with much lower growth than the other two) and has been instrumental as a platform for the development and cross-selling of private and public cloud services: many current customers migrated or upgraded from web hosting services to cloud services.
As part of its growth strategy, OVH is also trying to implement a comprehensive PaaS offering (storage; DataBase-as-a-Service; analytics; …) to overlay on its IaaS products, mostly through partnerships and acquisitions: in July 2021 it acquired BuyDRM, a US specialist in security & encryption, for €14 million and in April 2022 it bought ForePaas, specialised in the field of analytics, for €18 million.
And (bien sûr!) are you even a serious tech company if in 2023 you do not include AI, machine learning and quantum computing as part of your new, revolutionary strategy?!?3
Market size and trends
At the global level, the Public Cloud market is dominated by the so-called hyperscalers (Amazon Web Services, Google Cloud Platform and Microsoft Azure), which together represents 70% of worldwide public clouds. In Continental Europe, their market share is similar at approximately 66%, followed by IBM Cloud at 5% and OVH at just 1%: in Public Cloud OVH is still a challenger along with other providers such as DigitalOcean.
On the other hand, the global Private Cloud market is more fragmented, with the top five players representing less than half of it. While the data is not recent, according to Forrester OVH is one of the two leaders (together with IBM Cloud) in hosted private cloud services in Continental Europe based on its current offering, market presence and strategy.4 Other private cloud providers include Hetzner (Germany) and Leaseweb (Netherlands), both private.
Public cloud is expected to be the most dynamic segment, with anticipated annual growth of 25%-30% from 2020 to 2026 globally, driven by high scalability and the large range of potential usages. But private cloud is also expected to grow substantially, as businesses seek to combine outsourcing and robust data privacy protections, which are more difficult to ensure on public clouds: OVH anticipates annual global growth of 15%-20% to 2026, including 8%-10% for Baremetal Cloud and 17%-22% for Hosted Private Cloud.
The estimated TAM figures are necessarily subject to uncertainty and depend on who you ask, and actual growth may prove to be different (possibly significantly so) from the figures below (OVH is currently only competitive in IaaS).
Europe accounts for around 20% of the global cloud market: the IaaS segment is around €12-€16 billion, with Germany as the largest market (17%-20%) and France just behind (13%-16%). This includes an estimated amount of €11 to €14 billion for private cloud services (including Baremetal Cloud which represents €3.5 to €5.5 billion) and the rest for the public cloud. The European PaaS segment has a market size estimated at €11-€15 billion, including approximately €2 billion in France.
The market’s growth has been driven by a steady increase in business IT spending, and a continued trend towards outsourcing. Businesses are increasingly finding that outsourcing provides a number of advantages: costs are treated as operating expenses, while investments in IT infrastructure are capex; external cloud service providers regularly upgrade their systems (including security protocols), which is not practical for individual businesses; and outsourced cloud resources provide flexibility and scalability to meet peak or unusual demand loads, which cannot be matched by internal solutions without significant expense and delays in implementation.
Increasingly, customers are using “hybrid cloud” solutions that combine public and private cloud with on-premises resources in a multiple deployment model within a single organisation. Businesses are also tending to seek “multi-cloud” solutions involving the use of computing and storage services from multiple vendors, often to respond to different needs.
Will the cloud market’s hypergrowth trend continue in the coming years? The industry is certainly becoming more and more essential for several processes, but gravity appears to be eating cloud computing growth.
Does OVH has any competitive advantage in the space?
A comprehensive suite of solutions
The mix of private, public and web cloud solutions allows the company to capture the growing demand for multi-cloud and hybrid cloud services by serving a wide range of needs and customer segments.
The company addresses the core cloud computing needs of this customer base with products and services that are more targeted to their needs as compared to hyperscale cloud offerings, which are more suited to large enterprise companies.
A vertically integrated model
OVH operates a unique, vertically integrated production model encompassing each step of both server and datacentre lifecycles: manufacturing, operations, network resources and IT infrastructure management.
By designing and assembling all its servers in-house, OVH is able to optimise server design and bypass intermediaries, as well as to reduce costs, increase customisation, reduce delivery time, and increase lifecycle management efficiency through retrofitting servers.5 This enables OVH to create a substantial cost advantage that differentiates it from other providers and facilitates operational efficiency and price leadership.
Growing demand for data sovereignty
OVH’s offerings are differentiated from those of other providers, particularly the hyperscalers, through a guarantee of data sovereignty, a factor that is becoming more and more important in reaching enterprises and especially public entities: guaranteeing customers access to a cloud service protected against interference by non-European authorities is essential for many public and private organisations that process very sensitive data.
Data privacy is a major concern in Europe (much more than in other regions), with companies required to comply with GDPR restrictions on the transfer of personal data to other countries, including the US. European customers are also seeking cloud solutions that are not subject to subpoenas and warrants issued by US law enforcement authorities under the US Clarifying Lawful Overseas Use of Data (CLOUD) Act.
This is not a purely theoretical consideration: there is a rising tide against the global dominance of US mega-tech companies, see for example the recent political storm that led to the withdrawn of a US economist from the appointment in the European Commission’s competition division, including comments by Emmanuel Macron (“It would be better to find a great European to police Big Tech”). France is one of the most vocal EU member states pushing for Europe to cultivate its “strategic autonomy”.
These constraints are leading European customers to look to alternatives to the US hyperscalers and other US-based cloud providers: as the only Europe-based pure cloud provider of this size, OVH is able to meet the requirements of European customers for data sovereignty and security.
Ok, time for some financial numbers
Well, actually not much: the company is not a start-up, but it has been listed for less 2 years so there are few details on its track record.
Revenues have grown approximately 12% p.a. since 2018, with an acceleration to 16% in the last couple of years.
OVH is positive at the EBITDA level, but after depreciation it’s barely breaking even at the operating level (plus, it has around €725 million in gross debt – including lease liabilities - to service). Profitability is obviously better on an Adjusted EBITDA basis, which in its specific case excludes share-based compensation, earn-outs and other non-recurring items. But we all know that EBIDTA is not profits, let alone FCFs, in particular for capital-intensive companies.
It’s not an easy task to compare OVH directly with the hyperscalers, as their services tend to be more complex and integrated with their other activities.6 At the very indicative level, AWS seems to have operating margins around 30%, while Microsoft is higher at 40%-45%. Google on the contrary is still reporting an operating loss in cloud, but I think it’s due to the allocation of corporate costs to the business.7 The closest comparable to OVH is DigitalOcean which is also losing money. And all these companies have grown revenues faster than OVH over the last 3 years.
At least OVH claims to be competitive on pricing (1-GPU price cheaper on a monthly basis for public cloud) and to be able to increase prices in line with the rest of the industry.
So, the underlying market is growing, the company is winning new businesses and clients, but it’s also burning cash equally fast!
When analysing FCFs, I like to use this scheme (h/t to The Secret CFO on Twitter)
This is how that table looks like for OVH (cumulative cash flows since 2018):
Capex is set to remain elevated at ~50% of revenues (roughly split in 20% for recurring capex and 30% for growth capex), with 70% of the physical investments dedicated to servers: datacentres currently do not need any expansion to accommodate the additional equipment. That means an annual run-rate for capex of around €350-€400 million, an amount that is currently NOT covered by cash from operations: the IPO was indeed a necessity to raise much needed fresh capital.
Debt is also not insignificant: the biggest tranche, a €500 million term facility that matures in 2026, carries a floating rate at Euribor + 1.1%, but it has been hedged for three quarters at an average cost of 2.3% (the all-in cost of debt is around 2.6%). According to the company, the current level of net debt/EBITDA (2x) is well below the danger level, but if you substitute the more conservative (EBITDA – Maintenance capex), the ratio almost double to 3.9x.
And finally, valuation. Overall, OVH is not really expensive, even on an absolute basis, at 7x-8x forward EV/EBITDA, and much cheaper than for example DigitalOcean (which however has a slight better expected growth). It also carries much less debt than the two US competitors.8
OVH’s own multiples have also come down significantly since the IPO, both as the underlying metrics improved and the stock price collapsed.
My final two cents
Pro
Growing market: OVH serves the huge, underserved SMB segment, which is not well covered by larger cloud vendors, at an inflection point where these businesses are quickly transitioning to the cloud and digitising
Trends toward multi-cloud / hybrid cloud solutions
Most of the revenues (private clouds) are on a subscription-based model with monthly fixed fees rather than on a consumption-based model (public clouds)
National protectionism (do not underestimated it in France!) and data protection in EU
Cons
Not profitable and with some debt
Competition from better capitalised, large-scale public cloud service providers with greater financial resources and from smaller, niche cloud providers: hyperscalers could easily choose to focus more on the SMB market and start a price war
Ability to sustain high revenue growth is not a “given” and will require exceptional execution skills, including scaling the sales force, introducing new products to meet evolving technology needs, upselling existing customers, improving customer retention and effectively managing capital efficiency
The stock price is down roughly 50% since the IPO: is the market too anchored on short-term profits and missing the long-term big picture?
Could be, but considering the current sentiment and the very divergent performance of OVH vs DigitalOcean - especially this year – that does not seem the right explanation, as the two companies have similar prospects, issues, … So, is there something specific to OVH that investors don’t like (maybe the low free float)?
The elephant in the room I think is: “can they keep financing the expected growth in revenues without a material improvement in profitability?” If the answer is no, OVH will either have to slow growth (which impacts valuation multiples directly) or probably raise more equity (which also impacts valuations via dilution). [Btw, this is - again - valid for DigitalOcean too, so the above performance is still puzzling]
A final note: having a fixation for FCFs, I admit I always struggle to value fast-growing, cash-burning companies in new industries (including the likes of Amazon since 2010). I have likely missed something important in the analysis: if anyone knows the company/industry better than me, feel free to add your insights either here or on Twitter (sorry, X…).
For example, some of the things I need to dig deeper into:
Is size a factor in pricing? OVH says to be competitive with the hyperscalers, but they all say it: to answer the question one would need to their speak to their clients and compare pricing vs service level
Is running private clouds more expensive than public clouds (for example, higher required capex)? This would imply lower margins and low ROIC forever
What is the payback period on capex (servers)?
The company does not provide ARPU, so it’s difficult to understand whether they are successful in upselling clients to more expensive/complex solutions. It also does not discuss net/gross retention rates, there are just passing references to net values in the annual report
The group generally presents itself under the name of its main brand, OVHcloud, but the legal name of the listed entity is OVH Groupe.
While I was finalising this write-up, on Thursday July 27 the price jumped +7% on no apparent news: maybe some sell-side broker upgraded the stock?
DigitalOcean also recently announced the acquisition of Paperspace for US$110 million: its Gradient platform provides a suite of tools that simplifies the creation, training, and utilisation of artificial intelligence models for developers, data scientists, and researchers.
The Forrester Wave™: Hosted Private Cloud Services in Europe, Q2 2020
The Baremetal Cloud offering has a lower priced offering marketed under the “Eco” range, using refurbished servers that provide quality services at a reduced cost, while improving environmental efficiency.
The mega-techs also keep reshuffling their operating segments. For example, what Microsoft groups under “Intelligent Cloud” consists of public, private, and hybrid server products and cloud services (including Azure); SQL Server, Windows Server, Visual Studio, System Center; Nuance and GitHub. While revenues for Google Cloud Platform includes fees for infrastructure, platform, and other services, but also Google Workspace (cloud-based communication and collaboration tools for enterprises, such as Gmail, Docs, Drive, Calendar, and Meet).
AMZN/MSFT do not allocate corporate costs to the individual segments, while GOOG does: this would seem to indicate that the cloud business is MUCH less profitable than reported when all costs are taken into consideration?
I included Rackspace Technology (RXT), the biggest of the three, as there aren’t many direct peers, but I should have probably excluded it. RXT is a previous Apollo LBO (2016) which has re-IPOed in 2020, hence the high level of debt; it’s an “end-to-end multi-cloud solutions expert across applications, data and security”, so it’s more “consulting” than owning and renting servers.