“The interesting thing about cloud computing is that we’ve redefined cloud computing to include everything that we already do. I can’t think of anything that isn’t cloud computing with all of these announcements. The computer industry is the only industry that is more fashion-driven than women’s fashion.”

This was in 2008.

Fast forward to 2010. At the OpenWorld conference this year, Oracle announces :

“World’s Best Foundation for Cloud Computing: Oracle Exalogic Elastic Cloud is the world’s first and only integrated cloud machine—hardware and software engineered together to provide a “cloud in a box”. “

So, is cloud computing really new ?

The answer I believe is Marketing meets technological advances.

The concept of delivering software on tap (Software as a service – SaaS) is not new. While free internet based services like e-mail have been around forever, the concept of charging ‘per seat’ or ‘per account’ based charges for applications delivered over the web have proliferated quite a bit in the last decade.

Also not new is the concept of providing centralized computing resources  – either Raw virtualized  infrastructure (Infrastructure as a service – IaaS) or a stack ready to take applications (Platform as a service – PaaS). IT departments in large corporations will tell you they are already doing this. A lot of IT departments charge back the business based on CPU minutes and storage used – i.e pay per drink.

So, whats changed for cloud computing to become so popular – I believe it is the proverbial tipping point that is the combination of how ubiquitous SaaS, IaaS or PaaS have become and the fact that these are being provided on a computing scale that is unprecedented with the promise of instant limitless expansion. This combination was ripe for  going mainstream as a concept and as Larry Ellison said so eloquently put it, the computer industry is not the one to miss a trick.

Second Market facilitates employees, ex-employees, founders, investors and others to look for buyers and offload shares of private firms.  Buyers typically include Asset managers, Hedge funds, Venture capital funds and individual investors.

A report of the most recent Q2 2010 activity has been published here by Second Market.  A few things that stand out are that the pool of companies which were traded is thin and Facebook accounts for a lion share of completed transactions. Nevertheless it still amounts to approx $50Million of total transactions across all firms. A few new entrants catching investors interest include eHarmony, Groupon, Huffington post, Mozilla and Skype with Groupon topping the charts of people’s interest.

Private company stock  are not the only instruments whose sale/purchase is facilitated by Second Market. It also features various Fixed income instruments like Mortgage backed and other asset backed securities and other loans.

A key example application is web-based email.

With HTML 5, there are two kinds of offline storage available

1. Session storage

Maintains a storage area that’s available for the duration of the page session. A page session lasts as long as the browser is open and survives page reloads and restores. Opening a page in a new tab or window causes a new session to be initiated.

2. Local storage

Maintains a storage area that can be used to hold data over a longer period of time (e.g. over multiple pages and browser sessions). It’s not destroyed when the user closes the browser or switches off the computer

Given the above standards based support for offline web applications, Google is no longer putting new resources into developing its Google gears as stated in their blog

A new alternative is being presented by a site called ‘SharesPost’.  ‘SharesPost’ describes itself  as “a passive bulletin board that enables users to post non-binding indications of interest concerning the potential sale of private company shares”

SharesPost lets shareholders of private firms offer their common /preferred shares for sale at a price of their choosing. This includes shares with restrictions such as stockholders’ agreement, rights of first refusal and co-sale rights.  The restrictions are shown in the  seller’s listing of an offer to sell . In a similar fashion buyers can post their interest in buying shares at a price of their choice.

The key to the site is that it provides standardized contracts that either a buyer or a seller can pick up  and associate with their post to buy or sell. Once a buyer is  comfortable with the price and restrictions associated with the stock, both parties e-sign the contract and proceed with the transaction which is facilitated by U.S Bank through the use of an escrow facility.

SharesPost objective is to make it easy to bull/sell stock in interesting late stage private companies.  While this provides exciting opportunities for the average / small investor, there are a few points to note

• The minimum transaction size is $25,000 so it is not really for the ‘small’ investor
• U.S Bank charges a flat $2,500 for each transaction. This again reinforces the fact that you need a large transaction size to make this trade profitable after such fees
• The site offers Valuation research by certain third parties, but given the limited access to information by nature of these companies being private, you do not have the same access to company finances that a large private equity investor can demand and get. So valuation is tricky and so you will see a wide variation in bid / ask prices.
• The depth of the market is very shallow and is barely acceptable for a select few companies. So , don’t expect to see a lot of buy/sell offers

SharesPost is a very interesting concept that is in a very early stage of development and I certainly hope it takes off so that it provides the average investor with the same opportunity that wealthy individuals , private equity firms or investment banks have.

This category of financial instruments are the preferred stocks of publicly traded firms. Firms and especially banks issue preferred stock to investors in order to bolster their capital without having to issue additional common stock and hence diluting the value of common stock.These preferred stocks are either perpetual or may be redeemed by the issuing firm after a few years.  There are a lot of other wrinkles that preferred stocks have (like being convertible to common stock etc ) which are not relevant to the current discussion.

The upside for investors in preferred stock is that they are provided with dividends at a fixed/agreed upon coupon rate and these dividends have to be paid ahead of paying any dividend to the holders of common stock. The downside is that preferred stock does not usually appreciate in value similar to common stock. Preferred stock are traded on an exchange much like common stock and have more in common to bonds than to stocks.

Warren Buffett’s recent investment in preferred stock of Goldman Sachs and GE at a coupon rate of 10% has brought these instruments to the spotlight.

While the average investor may not get the same opportunity with Goldman or GE , there are other opportunities out there in the market due to the battering that preferred stocks have received (warranted or not) along with regular common stocks.

Risk and Reward

There are a few risks associated with preferred stocks :

- If the firm goes into bankruptcy, like common stock, they stand in line after creditors. However they get paid before any payments to common stock holders

- If a firm is in dire straits and if it does not pay dividend at all, unlike bond holders, preferred stock holders won’t get paid

These risks are out weighed by

- The tax benefits compared to bonds – these dividends are taxed at the lower 15% capital gains tax rate

- The materially higher dividends paid when compared to common stock and also the relatively stable preferred stock price when compared to common stock price

How to find the right preferred stock to invest in

The site www.quantumonline.com lists most of the traded preferred stocks that are eligible for the 15% dividend tax rate along with their coupon rate. This can be a launch point for your analysis.

There are a few preferred stocks that currently stand out based on their yield and their issuing firms ability to stay solvent in this turbulent environment – either due to the US Government implicit guarantee (Bank of America and JP Morgan) or due to excellent capital structures (HSBC and Allianz)

- HSBC (ticker -HCS) : Based on the current stock price, it yields 9.8%

- Allianz (ticker – AZM) : Based on the current stock price, it yields11.1%

- Bank of America (ticker – BAC-H): Based on the current stock price, it yields 9.07%

- JP Morgan (ticker – JPM-I): Based on the current stock price, it yields 8.6%

These are now worth looking at as a less risky (than common stocks) alternate to investing in bonds or staying in Cash.

Note : No asset class is safe these days with all kinds of  financial instruments which nobody realized existed getting into distress territory due to extreme fear and large out flows from them. The safest asset in the intermediate term seems to be US $ (not even gold) as no country/central bank holding it can afford to exit it without causing irrepairable self damage.

‘Prosper’ is the biggest player in this nascent ‘Peer to Peer lending’ space. It’s loan portfolio is still tiny compared to a bank and the track record is just beginning to take shape (earliest loans are dated June 2006).

Key features of Prosper

• Loans are unsecured and not FDIC insured
• Standard loan period of 3 years
• Borrowers are categorized into Credit grades of AA (760+), A (720-759), B(680-719), C(640-679), D(600-639), E (560-599)and HR (520-559). Credit scores are from Experian.
• You can automatically distribute your loan amount amongst a set of borrowers to reduce risk
• Delinquent loans are turned over to a collection agency which charges standard recovery commissions
• Prosper makes money by collecting fees from both lenders and borrowers

Given the intriguing nature of ‘Peer to Peer lending’ , I decided to do a bit of digging on how ‘Prosper’ loans pan out as an investment option. Here are some findings :

Typical Interest rates

Here are rates ( during the last 30 days) for loans between $1000- $5000. (Taken from Prosper website)

AA 7.65%
A 10.01%
B 14.32%
C 15.10%
D 21.60%
E 27.52%

Delinquency

I found a blog “Fred’s” that used Prosper’s own data (provided on its performance page) to do an analysis on how the age of a loan affects its delinquency behaviour.

This is quite an important analysis as loans recently originated are usually less likely to be 1+ month delinquent compared to older loans. The problem is more severe as Prosper’s performance reports usually mix the performance of new and old loans and thus make it difficult to judge loan behaviour over time.

The above chart (taken from Fred’s blog) shows the following for loans originated in any one month – % of loans that are 1+ month late Vs the number of elapsed days from the loan origination month. Interpreting data for one particular month – say June ’06, it shows that 10% of loans for that month went delinquent after 180 days (from June ’06) and 19% of loans for that month went delinquent after 360 days (from June ’06)

Note that the curves show the same pattern across months and on average 16-24% of loans become delinquent 360 days from when they are originated. This is a staggering rate.

However, it is very important to note that this analysis is across all credit categories.

In order to analyze delinquency by credit category, I took a snap shot of Mar ’07 loans’ performance data from Prosper website and the situation improves dramatically for AA and A categories.

AA loans – 1+ delinquency rate is 3.55% by value and 1.11% by number of loans

A loans – 1+ delinquency rate is 12.58% by value and 6.02% by number of loans

As you can see, this is a far cry from the 16-24% one year delinquency rate across all credit categories.

Collection agency effectiveness

The record is quite dismal in this respect. Over the last 3 months, their largest collection agency by volume of delinquent loans sent to it (‘Amsher’) has collected only 8.47% of the dollar value sent to it for collections for AA and A borrowers and the % collected falls of to 3.92% for B-D borrowers.

Since loans are sent to the collection agency just one month after they are past due, the above recovery percentages are quite dismal and it means that once a loan goes delinquent there is little chance of getting your money back.

Sale of distressed debt

If loans stay uncollected for 3 months with the collection agency, the loans are sold to a distressed debt buyer. The metrics for the last such sale by prosper yielded 9.6% of principal amount for AA and A borrowers debt. The trend from Prosper’s metrics over the last year shows that distressed debt buyers are paying less and less of the principal which may be a reflection of the current economic environment and the general risk aversion to less than perfect debt.

Summary

It may pay to lend to AA borrowers as long as you spread your loan across a wide set of borrowers. I would not suggest lending to any other credit grades till Prosper tighten’s up borrower verification and collections effectiveness.

On the face of it, this sounds like a loss for Google, but per my earlier post, this is in fact the best possible outcome for Google. Google must have strived hard during the bidding process to loose while at the same time ensuring that a rival firm bid above the $4Billion minimum limit to keep the spectrum ‘open’. The auction ended with Verizon bidding just 3% above the FCC minimum.

‘Open access’ means that any network deployed on these airwaves would have to be open to any device and any application. That is contrary to the cellular carriers’ traditional walled garden strategy where they supplied the equipment and locked customers into their networks and favored their own content.

At the same time, expert practitioners have put forward a variety of formal methodologies to guide project teams though the software development process.

For the most part, these methods fall into two camps – the Predictive/Watefall category or the Iterative/Adaptive category.

Predictive/Waterfall approach

This is the traditional approach to software development where the team progresses sequentially through the various development phases – planning, requirements, design, coding , testing and implementation. The key aspect here is that there is no going back/revisiting once a phase is complete.  A fixed scope with no feedback loop is the biggest drawback of this process. 

Iterative/Adaptive approach

This approach has seen the most activity in terms of new methods with the Agile family of methods being the most recent and popular. The basic principle is to use shorter delivery cycles to deliver the end product/software quickly by constantly taking in feedback from the end users.

Typical methods falling under the agile umbrella include Feature driven development, Lean development, Xtreme Programming (XP) and the Dynamic systems development method.

While each of the above iterative methods have their own rules and method of operation , they are more common than they are different. In my experience I found that you don’t actually take up one specific method and follow it to the ‘T’.  It is more realistic and useful to evaluate your current situation and organizational environment and pick the aspects that work in each method to build your own process.  In real life, projects end up looking like they have followed  a mix of the above methods as each project team evolves and modifies its process as they execute projects. This happens naturally rather than by design.

How do teams pick their development methodology

I have found that the following have an impact on what development process a team ultimately gravitates to:

• Size of the technology eco system the project team is in. Is the team a part of a large technology organization ?
• How many different application teams are typically impacted by projects. Are applications very much inter-connected in an enterprise environment?
• Are all members of a project team present at the same location
• Are the end users of the software co-located with the development team
• Nature of the application – Web based Vs a thick client
• Criticality of ‘time to market’ for the organization
• Capability of key developers and management’s trust in their ability to execute independently
• Whether the project is  Product development or internal enterprise application systems enhancement
• The industry the project team’s firm belongs to

Here are a few practical examples of different flavors of software development methodologies that have been adopted by various firms that I have been associated with and also a few pointers to why they have adopted those :

A large global financial organization

- Goal is to build and enhance Enterprise application systems
- Uses Waterfall methodology with clearly defined phases for planning, requirements, design, coding , testing and implementation
- Scope change needs are addressed through a Change control process
- Co-ordinated testing and Implementation is required across applications leading to a pre-defined and common release calendar
            – A single project typically spans a lot of applications
            – Each application is impacted by multiple projects
- Large number of users who need to be formally trained. This limits the capacity/appetite for frequent releases.

An analytics products development firm
- Web based Product development
- Software used as a service by internal users as well as external clients
- Users co-located with key development staff
- Iterative development to release features quickly
- Internal professional services users can educate clients on incremental feature upgrades leading to a smooth absorption of new functionality
- Software hosted on internal servers that enables quick and seamless delivery of new features in small incerements
- Shades of Dynamic systems development method
                 – Timebox development effort to come up with a release every 2-3 months with a fixed set of resources
                 – When features involve fundamental / core changes that take longer, the time box elongates.
- Shades of feature driven development
                - When the timebox is longer,there are iterations within the release to design,build and test features incrementally. There isn’t a wait to build all features and only then test them.
- Shades of XP
                - Refactoring of code/design included along with other features during iterations

A provider of software as a service

- Revenue model – Software as a service through web based applications
- Short release cycles (<2 months)
- Iterative UI design through HTML Prototyping
- Shades of lean development
             - Build a minimal feature set to begin with for each application
             - Start selling the service
              - Add features iteratively as needed

A Technology products development firm
- Shrink wrap product development. Products are ‘installed’ by users
- End user Product release cycles are long – 6 months to a year
- Large number of iterations internally till the product is considered to have enough features to warrant a release
 - Shades of feature driven development
             - Features distributed amongst developers who built one set and then went to the next
 - Shades of XP
             - Design, coding and testing done together  
 - Emphasis on building working software and not so much on documentation
             - A working build is available each day with the latest changes.
             - Management, other developers and sales and marketing teams can watch the software being built and provide input and plan their own activities
 

As an experiment, I have posted the portfolio holdings and its NAV (Net Asset Value) on this website under  ”My Stock Portfolio“. I will be updating the holdings and the NAV on a monthly basis.  Readers of this blog will have a chance to track the portfolio performance and make decisions for their own portfolios.

Note that this is an experiment and may be discontinued if personal or other situations  demand it.