It has not been a great earnings season for the networking hardware equipment makers, especially those in the service provider segment. All through the food chain, from chips to routers, margins and sales are on a disappointing trajectory.
This has been happening for a while, and I predict it will get worse. The advent of Software Defined Networking (SDN) and Network Functions Virtualization (NFV) cannot be underestimated. It’s shaking up the way networking hardware and software are delivered, and changing the business models.
If you don’t believe this, take a look at some of the earnings signals from the past month:
- Juniper (JNPR) shares tanked on Q3 earnings, which the CEO called “disappointing.” Both revenue and profits came in below expectations. Long-term revenue has been in decline.
- Ciena (CIEN) shares recently hit a new one-year low. Analysts have been slicing price targets. This has mostly been driven by generally weak pricing on optical equipment.
- Shares of Cyan Inc. (CYNI) this week hit a new all-time low of $2.76. The company went public in 2013 at $11 per share.
- A warning from semiconductor company Microchip (MCHP), which sells into all sorts of end markets ranging from wireless networks to embedded systems, freaked out the semiconductor market. Shares have bounced a little, but the stock chart still looks sketchy.
What’s going on? Many networking hardware companies are having to make pricing concessions, and they are under pressure from the advent of the new white-box model, which puts networking software on commodity server hardware, which I’ve been writing about for a while.
The big vendors — especially router vendors Juniper and Cisco — are not reacting well. As sources tell us, Cisco (CSCO) is scrambling behind the scenes to get its SDN and NFV stories together — but the real problem is pricing, and what that does to the sales force. When you are selling into markets that are rapidly being commoditized, you have no pricing power.
MKM Partners Managing Director Michael Genovese says these fears have picked up in recent months, and it’s a top question that he gets from investor clients. What does SDN mean for the networking market?
Genovese observes that Juniper had a sub-par analyst day two weeks ago, which did not support the stock price. He says that management spent too much time talking about how the market still wants specialized routers with ASICs (Application Specific Integrated Circuits), and that white boxes were a ways away.
“I want to hear more about software,” says Genovese. “There’s a massive opportunity to sell software. They spent too much time talking about ASICs. ”
Genovese wrote about this in an investment note issued on, of all days, Halloween:
We would have liked to hear a thoughtful discussion of how the Routing and Switching markets will evolve over the next decade driven by the impact of the mega-trends of NFV/SDN. Instead, we heard the CTO dig in his heels and essentially say, “All the pundits in the market are confused and wrong, Routers will never lose any of their place in networks and merchant silicon cannot replace ASICs when it comes to high-level Routing functionality.”
That about sums it up. The big routing companies, including Alcatel, Cisco, and Juniper, are in denial. Their market is under assault, and they can’t get their plans together fast enough.