Reading Cisco’s Earnings Through a VMware NFV Lens

Cisco came out with their numbers, and while I could talk about them by themselves, I think it might be more helpful to consider them in light of some other news, which is VMware’s decision to get serious about NFV and even Facebook’s tossing in a new data-center switch.  I’ll mention some Cisco-numbers commentary where appropriate, but I want to open with some quotes from John Chambers:  “Let’s start with a basic question, like why Cisco?”, and end with “We are well positioned for a positive turn in either service provider or emerging markets. But we are not modeling those turns for several quarters despite the better results we saw in this last quarter….”

VMware and Cisco have a lot of competing dynamics and a lot of common factors.  Most recently, NFV as a technology to support has joined both groups, a response to the market conditions on the provider side.  The reason is obvious; my model has been showing that NFV is likely to be the largest single source of new data center deployments for the next decade, and also likely the largest single source of new server deployments.  It will consume the most platform software and the most new management tools, and frame cloud computing’s future.  That’s a heady mix; too much upside to ignore.

The challenge for everyone in the space is that Facebook proves that if you build data centers for net-centric use, you may find it easier to design your own stuff, or at least pick from commodity white-box options (Cyan and Pica8 had some new developments in these areas earlier this week too).  The obvious solution is to rely on symbiosis to get a piece of the new action.  If you can support the NFV revolution that’s driving change you might stave off the wolves.

For VMware, there may be another dimension.  Nothing feels better than to rub a rival’s nose in a dirty dog dish, and that’s less risky when the rival is chained.  Cisco has demonstrated that because of its hardware dependency, software-defined anything is considered a risk to be managed not an opportunity to be seized, which attitude somewhat limits Cisco’s aggressive options.  VMware has no incumbency in network equipment and so can dance wild and free into the virtual age.

Let’s get to John’s early question, “Why Cisco?”  This has two faces, one of which is why Cisco is doing what it always does, which is be a fast follower.  Cisco’s need to sustain its near-term hardware revenue stream creates for the company is significant.  Most of what Cisco announces these days boils down to 1) assertions that the “Internet of xxx” where “xxx” is anything exciting and different (Chambers did his Internet of Everything routine on the call), generates a boatload of new traffic operators have a Divine Mandate to carry or 2) enhancements to switching/routing protocols to create SDN-like features without having to adopt white-box SDN.  The second face is “Why Cisco?” in the sense of why buy from them, and for network operators it’s clear the answer has to be “because they’re supporting where we need to go”.  That’s clearly at odds with the first interpretation of that same question.  They’d like Cisco to lead in NFV.  They are not, which is probably a factor that VMware has noticed.

However, VMware has its own issues.  Their stock has been in general decline over the last six months as financial rags tout views like “Virtualization in Decline!”  Under pressure from open-source software in the cloud, they can hardly afford to ignore an opportunity like NFV, but their traction opportunities are a bit slim.  Cisco is a server vendor, which means they have a big financial upside from all those servers and data centers.  VMware can hope for a platform software upside on a hosting deal, but servers cost more than platform software, particularly when so much operator focus is on open-source versions of what VMware would like to license to them.

If you look at NFV objectively it’s hard to see why Cisco would find it such a threat.  Because NFV could at least admit standard boxes under the NFV tent through generalization of the Virtual Infrastructure Manager (which HP and Oracle among others have already proposed) it could build a layer above both legacy boxes and evolved network device notions like SDN.  That might reduce operators’ interests in changing out gear by making it unnecessary to switch switching (so to speak) just to talk to it from NFV.

Part of the explanation may be Cisco’s beating the revenue line, which came about because it increased revenue 7% y/y after a bad similar quarter last year.  It’s hard not to see this as a possible indication of a rebound in carrier capex, especially if that’s what you devoutly hope it is.  Stay the course a few quarters longer and 1) Chambers can retire on an up or 2) he won’t have to retire at all.  Take your pick, Chambers-watchers.  But even Chambers has to admit that nothing is turning around for the next couple quarters and their forward growth guidance of about 4% reflects that.

VMware is probably salivating over Cisco’s business challenges, but it has its own issues.  The cloud has jumped more on OpenStack than VMware hoped because public cloud has been much more valuable than private cloud, which VMware could have supported easily (and did, belatedly IMHO) as an evolution of virtualization.  Cisco took the OpenStack approach but while aggressive action there might have at the least handed VMware its head by advancing OpenStack more visibly, Cisco has been more interested in differentiating UCS than promoting standards.

UCS growth was strong in Cisco’s quarter, up by 40% compared to switching’s 11% and routing’s 2%.  But UCS was a bit under $850 million when routing was about $1.8 billion and switching double that.  You can see that Cisco needs more UCS but doesn’t need it to indirectly (via SDN and NFV) cannibalize switching and routing revenue.  And above all it doesn’t need any weakening of account control.

Now we have an NFV war, which pits a new (and thus totally hazy) VMware offering against a Cisco offering that’s always seemed more like and NFV billboard than a product.  Cisco doesn’t sing a bad NFV song (it sounds in fact a lot like Oracle’s story on the surface including the TMF-ish CFS/RFS angle) but they aren’t singing it out loud and strong as another song goes.  VMware has a chance to take a lead in positioning…if…

…they can figure out something to say.  Obviously parroting Cisco’s story with more verve and flair would be better than nothing (or even than Cisco) but probably not enough given that others in the space are demonstrating substance.  VMware needs to join my club of players who actually can do something to drive NFV, not the club of NFV hype artists (a much larger group).

So does Cisco, not only to compete with VMware, but also to compete with Oracle and Alcatel-Lucent and HP and even Overture.  There are big companies with big stakes in the ground leaping on the NFV bandwagon daily, and it’s hard to imagine none of them have taken the decision seriously.  I suspect that Cisco did too, and took the tactical short-term approach.

The stakes are rising now and it’s time to get to the last quote from the call that I opened with.  Chambers admits that the service provider market isn’t going to turn around in a few quarters.  Earth to John: It’s never going to “turn around” in the sense of returning to investment patterns of the past.  You just gave yourself a couple of quarters to face facts, as so many of your competitors are obviously doing.  I’d get moving if I were you.

They could, too.  Cisco’s NFV story may be a billboard but I think I know the company well enough to know that what’s missing is intentions and not capabilities.  They almost certainly have as much as Oracle or Alcatel-Lucent, at the least, and they have a lot of inventive people.  And their desire to preserve the present could align pretty well with operator goals not to sink themselves in accelerated write-downs.  If Cisco could get the orchestration/operations story right they could come out of this quickly.  Faster than VMware for sure, unless they bought their position.

That’s my advice for VMware.  Unless you already have a product sitting somewhere waiting for an organization to spring up, you’re going to need to start spending like a sailor on M&A and hope that John waits just a little bit longer.  Hope, but don’t bet on it.