The Data Deluge

Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.

Whether we like it or not, we are being deluged by data. This much seems certain in what are still generally uncertain times. We discuss below data’s growth, the challenges related to its development and some investment implications. First, some context: take You Tube. Over 2bn videos are watched each day and, an average of 24 hours of new content is uploaded every minute. Next, take Wal-Mart, the world’s largest retailer. Its revenues are bigger than that of many nation states (Argentina, for example) and the organisation comprises more than 8,900 stores employing over 2m people globally. At Wal-Mart, 200m customer transactions are processed weekly, equivalent to over 1m every hour. What these examples serve to highlight is more than just the ubiquity of data, but its surfeit. As increasing quantities of digital information are produced, they need to be stored, managed and potentially protected. It is here we have the biggest problem: put simply, today, there is just not enough space.

Two primary factors are driving the data deluge: the transition from analogue to digital, and the increasing adoption of the internet by both businesses and consumers. Underpinning these factors are increased efficiency benefits. All major forms of media – voice, television, radio and print – are now embracing the digital world as are an increasing number of industries. Utilities talk of ‘smart grids’, the oil and gas majors are already mapping ‘digital oilfields’ and the healthcare industry is moving towards electronic patient records. IBM cites some tangible examples in its most recent Annual Report: in a study of over 400 cities, those that employ smarter digital transportation solutions (such as ramp metering, signal coordination and incident management) reduced travel delays by an average of more than 700,000 hours annually. Meanwhile, eight hospitals and 470 primary care clinics in Spain that implemented smarter healthcare systems across their facilities experienced operational efficiency gains of up to 10%.

Yet, we are just touching the tip of the iceberg. There are currently 1.97bn global internet users (already five times more than ten years ago), equivalent to 28.8% of the world’s population. Of these, more than 500m use the internet at least once a week (according to Nielsen market research). However, regional differences are significant, with 77% penetration in the US, 58% in Europe, 35% in Latin America and 28% in Asia. Over the coming years it seems highly reasonable to assume that global adoption rates will move towards US levels and time spent on the internet should also rise. Remember, the internet is inherently democratic, globalizing the way in which businesses and individuals communicate; with very low investment, anyone can have a webpage. Google, whose mission statement is to “organise the world’s information and make it universally accessible and useful” receives over 3bn queries a day, or 35,000 each second, and has over 3m servers globally processing this information.

At the end of 2009, the ‘digital universe’ (to borrow a phrase coined by EMC) comprised 0.8m petabytes, but had grown 50% to 1.2m petabytes (or 1.2 zettabytes – see the appendix below) by the end of 2010. In ten years’ time, the digital universe will have expanded by a factor of almost 30 times, reaching 35 zettabytes by 2020, according to IDC, a consultancy. However, even today, if every person wanted to store every byte of digital content created, there would be a shortfall of around 35%. This gap is expected to grow by more than 60% over the next ten years; in other words, more than 60% of all new data created will not be able to be stored. Given the current rate of growth, this estimate may also be conservative. Over the years, many different forms of storage have been invented, but so far, no practical medium exists, and all forms of storage have some drawbacks.

Another major challenge inevitably associated with the inexorable expansion of the digital universe is that of security. Put simply, as data grows, so do security needs. One only need think of Wikileaks (a non-profit organisation with a database of more than 1.2m documents that publishes submissions of private, secret, classified media from anonymous news sources and leaks) and Stuxnet (a Windows computer worm discovered last year that targeted uranium enrichment infrastructure in Iran) as two clear recent example of digital security being compromised. According to IDC’s most recent study, by 2020 almost 50% of information within the digital universe will require a level of IT-based security beyond a baseline level of virus protection and physical protection. Viewed from a different perspective, only about 1,000 exabytes of data need protecting today; by the end of this decade, the figure will have grown by at least eighteen times.

Three key questions arise from the above: how will we find information when we need it; how will we protect the information that needs protecting; and, how will we comply with (future) government and industry regulations regarding the retention and tracking of information? Over $4 trillion is already spent on hardware, software, services, networks and IT staff to manage the digital universe, and while IT spending is set to increase (by c 5% p.a. through to 2014 according to Gartner, another consultancy), there is also an associated need to spend more intelligently. We are not only in EMC’s ‘digital decade’, but also in what IBM calls the ‘smart decade.’

Virtualisation and a move towards cloud computing represent partial solutions to the data deluge. In the case of the former, this means creating a virtual (rather than an actual) version of something, such as a hardware platform, an operating system or, importantly, a storage device. Chief Information Officers cite virtualisation as their number one priority, according to a January 2011 survey by Morgan Stanley. Virtualisation is inextricably interlinked with the transition towards ‘the cloud’, an overall trend in which computer processing power is seen as a utility that clients pay for only as needed. In other words, cloud computing allows consumers and enterprises to share sophisticated pooled computing infrastructure services. Massive hardware/ software infrastructure (like a utility grid) is utilised by an end-user as and when required, much like electricity is today.

Spending on cloud related activities totalled $8.5bn in 2010 according to Gartner and is set to enjoy a 6.7% p.a. CAGR over the coming years, ahead of the broader IT market. This may not be enough, particularly if IDC is correct in calculating that of the 35 zettabyte digital universe foreseen in 2020, over 15% of this data will ‘live’ permanently in the cloud, while almost one-third will pass through it at some point. Reproduced from its 2010 Annual Report, Microsoft believes that the impact of cloud computing will be “as big as – or bigger than – the previous waves of technology change.”

As dynamic as cloud-related spend is set to be, CIOs should not forget the importance of security-related spend (ranked only as fifth priority in Morgan Stanley’s survey). One concerning statistic, again from IDC, is its estimate that the amount of data that will be unprotected by 2020 will be equivalent to the whole of the digital universe in 2018. Security matters not just for corporates, but also for individuals: less than half of the universe that is created by individuals can currently be accounted for by user activities (pictures, phone calls, emails) while the remainder constitutes a digital ‘shadow’ (surveillance photos, web search histories etc). Moreover, what a consumer or company wants protected may change from day to day depending on circumstances or because of changes in the originator’s own status.

Can anything stop the digital bandwagon? We are doubtful. Growth appears exponential, demand compulsive and the efficiency gains indubitable. The trends of mobility and smart phone development (not the main topic of discussion here) will only likely cement further the pervasiveness of the digital universe. Gartner forecasts that global smart phone sales will exceed PC sales for the first time in 2011 and there are more than 4.6bn mobile devices in existence worldwide at present. IT spend is inevitably partially dictated by the economic environment (notwithstanding IBES expectations for 15% developed world profitability growth in 2011), but one key conclusion from our analysis is that for many corporates and consumers it is not an option not to spend. In other words, even if arguments can be made for deprioritsing spend on data storage, management and retrieval (accepting that not every byte of information can or will be stored), data security seems to be one area where there is less scope for compromise. We have already witnessed some of the potentially destabilising effects data security breaches can have, and growing globalisation only exacerbates the risks.

From a stock picker’s perspective, there are many potential ways of gaining exposure to the still-fragmented theme of data deluge. Among the strongest beneficiaries, we highlight EMC, IBM and Check Point (other candidates would include Allscripts, Cisco, SAP, Symantec). EMC is a developer of a broad range of information infrastructure and virtual infrastructure technologies and solutions as well as being a play on the cloud, offering core storage market growth together with virtualisation, security, back-up and data warehousing. VMWare (81% owned by EMC) develops the servers that form the basis for the majority of current global server virtualisation. Next, IBM: the company has successfully transformed itself from a hardware to software-oriented business (more than 60% of its revenues from the latter, which is growing over 250 basis points faster than the group). Its applications are designed to provide efficient solutions to corporates and are geared towards outsourcing and virtualisation. More than 25% of IBM’s R&D spend is also currently being spent on virtualisation and cloud-related projects. Finally, Check Point is the worldwide leader in offering unified data security solutions, ranked number one by worldwide VPN/ Firewall software revenue market share and used by 98% of the Fortune 500. These three names are among today’s winners, but as the information surfeit grows, so new companies will be spawned. As the world becomes (ever more) digital, we at Heptagon Capital are hopefully prepared.

Alexander Gunz, Fund Manager, Heptagon Capital