Contradiction: The Street’s View of Networking in a Nutshell

It’s sometimes nice to end a week with some analysis of the Street’s view of networking.  To hear that there are sometimes contradictions is likely not going to surprise you, and I think contradictions often expose some interesting truths.  They also give me a chance to lay out a financial view of industry health.

JP Morgan issued a research note that said, despite many notes and stories to the contrary, that carrier capex is actually poised for an increase.  The reason they give is that the ratio between capex and sales has actually been increasing, and that means that as sales now grow capex might explode (I paraphrase, of course).  In the same note, they say that SDN is going to have an impact on enterprise networks between now and 2015, shrinking the data center switching market by as much as a third.  In summary, their view is that there are structural (like “server refresh cycle”) drivers to grow carrier capex, and that SDN will hurt the only robust area of enterprise network spending.  Got it?

At almost the same time, we heard a rumor that AT&T was looking to buy a European wireless carrier.  Hungry for new customers in a saturated market, faced with flat-to-declining ARPU in the US, AT&T would flee to Europe.  The presumption behind this is that a company looking, as all network operators do, to long-term growth, would see their best option as buying a cheap carrier in Europe, not buying infrastructure to convert into service revenue.

Well, the contradiction here is a good place to start.  According to JPM, here’s AT&T, with new customers drying up and ARPU in the mobile space at a plateau, preparing to decline.  So what do they do?  Increase capex!  Yes, they sort of said that they were doing some of that in certain areas, and so have other operators.  In a competitive market you sometimes have to spend a bit more than you’d like.  But nearly everyone who’s looked at the numbers says that operators are simply not going to spend a lot on equipment, particularly in wireline.  It’s hard to square an operator deciding to run to Europe for growth with the notion that things are rosy enough to justify network investment here.  Net?  I think that the capex-to-sales argument is lame. It’s not going to create a rising tide to lift all network boats.

Surely not lifting all boats in the enterprise, because according to JPM, the SDN juggernaut is going to hit the data center and create pressure on Cisco, who has more enterprise exposure than other network vendors.  This, by 2015, is going to hit data center switching revenue by a third!

Well, I don’t think so.  My surveys say that enterprises believe the data center is the HOTTEST space for the next three years, the place most likely to get more spending rather than less.  Cloud deployment is a drive for both enterprise data centers and provider data centers, and of course the gear is the same for both.  The market is so good it’s a shame SDN is going to eat it, right?  JPM expects, their report says, that vSwitch (Nicira) will likely win.  Hey, here’s some news; vSwitch is an overlay technology that doesn’t displace a dollar’s worth of gear!  You have to use the normal network gear just like before.  And vSwitch is mostly a multi-tenant solution, which isn’t a problem most enterprises have.  I’m scratching my head here.

What, then, is real?  Let’s look first at business networking.  Enterprises are going to be doing a number of things, from SOA and virtualization of old to private cloud of today, that will drive up data center spending.  Big data and analytics also drive it up.  My model says that that trend will continue through at least 2017.  Yes, we will see SDN features and factors play a part in buying decisions starting as early as this year, but the important point is that SDN in the data center is not driven by cost reduction goals but by performance and availability benefits, and the need to support IT changes (SOA, cloud) already funded.  Fabric switches, the big trend in the data center, aren’t necessarily any cheaper than stacks of LAN switches and certainly not 30% cheaper.

For the network operator, it’s even simpler.  Every single profitable thing an operator does with a customer has a traffic “range” of less than 40 miles.  Content is a metro application.  Mobile/behavioral or point-of-activity intelligence is wireless, and wireless is metro.  Cloud is metro.  There will be an enormous transformation of network spending to focus on metro.  That is going to help fiber players and device vendors to the extent that they understand that the architecture of that future metro network will be one designed to make the whole of metro look like a cloud data center.  The revenue available to fund this is huge, so it’s not the problem with capex.  The problem is that vendors still can’t tell a sensible story to operators that link the business value of operator infrastructure to spending decisions.  No credible benefit equals no secure spending.  So net?  Operators are likely to keep their foot on the capex breaks for at least a couple more years because, based on past history, vendors won’t present them with any new options to justify their new network spending.

Overall, though, the spending on network equipment is going to decline over time as it refocuses on areas where good ROI can be obtained.  As I said, there are no large-scale, good, secure, spaces there, which matters a lot to giants like Cisco who can’t hope to gain market share.  That’s why Cisco wants to be an IT giant; they need more revenue opportunity than the network can provide.  Smaller players can gain market share, startups perhaps create literally exploding value propositions, but these will have to be framed in the metro model I described for operators, and in the “enterprise SDN” model I’ve blogged about.  A few are nibbling at these positions, but nobody has them nailed down.  Go back to the error of JPM; there is no structural capex-to-sales revolution to save the industry.  It has to save itself, which is very possible but not likely to be accomplished by putting the ship on automatic pilot and going to sleep.

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