Citi has just initiated research coverage of the networking space, and I think it’s useful to look at what they say and compare it with what my own surveys and modeling suggest. Wall Street, after all, makes money for people by guessing right on stock trends. The big “however” here is that sometimes it makes money when the company isn’t; stocks aren’t a perfect indicator of fundamentals. Let’s see what Citi says, then, and make some assessments on fundamentals.
With coverage initiated on 16 network companies, Citi puts eight in the “neutral” category (Ciena, Corning, Ericsson, Garmin, Infoblox, Juniper, MSI and Polycom), assigns three “Sell” ratings (Blackberry, Brocade, and Cisco), and five “buy” ratings (Alcatel-Lucent, F5 Networks, Nokia, Qualcomm and Riverbed). Let’s look at what seems to be the overall thesis, then at some of the ratings that might seem a bit of a surprise.
According to Citi (we interpret) the macro conditions in the networking industry for the next couple of years will be unfavorable. Both enterprises and service providers are likely to spend to save and not spend to advance, which will keep revenue growth limited. Opportunities that develop will focus on narrow segments of the market, so people with a narrow footprint will tend to either hit (and be rated well) or miss (and be rated poorly) those good places.
Radical technology changes are not going to contribute as much opportunity as buyer-side initiatives that are most likely to perpetuate the status quo. If Citi believed that SDN or NFV would present a major opportunity, they’d cast somebody likely to capitalize on these technologies as winners, which they do not.
How does this thesis compare with my own predictions? Generally, pretty well. I think that buyers are interested in a new model for networking but they’re not seeing a complete solution to their problems or a complete addressing of their own opportunities. They will kick tires in 2014 and frankly be happy to do more, but they don’t think vendors will present them with the product mix they need for a radical change. They’ll buy influenced by things like SDN and NFV (they’ll demand a “strategy” or “architecture” and an evolution path) but they won’t buy a lot of either.
Among the buy/sell calls that I think reinforces my view is the “Neutral” rating they give Juniper and the “Sell” they give Brocade. Brocade has actually gained traction on SDN and NFV in 2013, as I’ve noted in the past. If you assume that traction could be linked to sales on a broad scale, there’d be no reason to put Brocade in the “Sell” column. With Juniper, the problem is that while the analysts think it has an opportunity, the new CEO is a wild card they say. Which says that the current Juniper strategy was a loser and they don’t know whether the new guy will do any better. That implies that SDN and NFV aren’t market trends that will shoot up like the old hockey stick, but rather are things that will require a lot of vendor prep.
How about the most “controversial” calls; Cisco as a “Sell” and Alcatel-Lucent as a “Buy”? If you polled people in the industry (and maybe even on the Street) you’d likely get a lot of pressure to switch those labels. But is Citi right?
Cisco’s challenge is that they’ve built up their sales over time in no small part by increasing total addressable market (TAM). Offer more and you can sell more. However, this is clearly a diminishing-returns thing because you necessarily go further afield from both your comfort zone/skill set and the magnitude of the opportunity as you keep picking those low apples. I think Citi believes that 1) Cisco can hardly gain much market share in its core markets and 2) it’s running out of attractive alternative places to be. I’m not sure they have this one right.
My surveys, as I noted yesterday, show that Cisco has by far the best influence trajectory in the cloud space, and has ridden those gains to match IBM in overall IT influence—a significant accomplishment. IBM built its success—the best long-term success in all of tech—out of account control and buyer influence so you have to give it a chance to work for Cisco in my view. I also think that Cisco has an appropriate strategy for SDN and NFV for the dominant player—make it into an evolution of strategy because the buyer is unlikely to be presented enough benefits for revolutionary change by any competitor. This is why Juniper is the potential Cisco-killer in the mix; it’s pretty likely they’re the only player who could create a revolutionary paradigm and make it stick (the management changes Citi cites do create uncertainty, but the old management would IMHO have certainly failed here). Net? I’d have given Cisco a Neutral.
Then there’s Alcatel-Lucent, who has a toe in so many ponds that they’re starting to look like moss. I think that broad exposure should have scared Citi under their thesis of specialized opportunity, but instead they like them. Why? It comes down to the fact that the new CEO has “brought focus” to key areas. In short, they seem to be saying that we like Alcatel-Lucent because they’re going to toss off all the sectors of networking that clearly aren’t going to be sterling opportunities and focus on the only ones that likely have a shot. I’m on the fence here too.
On the positive side, I do think that focusing on areas like wireless/LTE are important. However, Citi doesn’t capture what I think my surveys show is the key point. You can’t win in networking unless you can stretch out to win in the data center. You can’t win in the data center if you don’t win in the cloud. While Alcatel-Lucent has a cloud story (CloudBand) that I like, it’s not positioned as effectively as it would have to be in order for it to create the kind of influence trajectory Cisco has. You’d have to give Alcatel-Lucent a “Buy” on pure technical reasons—they suffered more in stock price than they deserve. The problem is that Alcatel-Lucent is way up YTD and Cisco is virtually unchanged. If you believe that Alcatel-Lucent could be the SDN and NFV disruptor that Juniper could (possible, not easy, for them as much as for Juniper) then you can justify a speculative “Buy”. On valuation I’d give them a “Sell” so that nets to neutral for me.
I think the important thing about the Citi coverage is that it’s showing an industry starved for innovation and unlikely to generate enough from any player to move the ball. Given all the opportunities to innovate that I believe are out there, that’s sad.