Networking Sector: Alternate Fronts Developing

There have been some major changes in the networking industry recently: Cisco acquired Tandberg for $3.4 billion, Lifesize was lapped up by Logitech for $408 million, and HP acquired 3Com for $2.7 billion. Responding to Cisco’s move, Juniper and Polycom have formed an alliance to offer videoconferencing systems and associated network infrastructure to service providers.

The video conferencing equipment market is expected to reach $8.6 billion by 2013, according to Gartner. While telepresence revenue grew about 28% to $325 million in 2009, all videoconferencing revenue grew over 5% to about $1.7 billion.

Juniper and Polycom’s relationship goes back a long way, but the recent alliance is being pitched as the industry’s first “conferencing-aware” network solution. The Cisco–Tandberg deal will have altered the competitive scenario in video conferencing, and this alliance should be helpful for pure-play video conferencing player Polycom. Juniper, on the other hand, gets exposure to a hot sector without actually making an acquisition or developing a product. Is a Juniper–Polycom merger in the wings?

The alliance will provide open standards-based video conferencing gear with video conferencing terminals from Polycom and networking gear from Juniper. It will be a cheaper option for enterprises and could boost Juniper’s 5% market share in the $5 billion enterprise router market. But Cisco, which currently dominates the enterprise market with a 70% share, is going to make sure that it will not be that easy. It is reportedly about to announce a new carrier core router that is seen as a better competitor to Juniper’s T1600. Cisco also dominates the router market with 60% share; Juniper comes in at 33%.

Juniper’s background is servicing telecom carriers with core networking equipment. As enterprises adopt cloud computing, the data center is becoming a key piece of their infrastructure, and Juniper is trying to leverage its core expertise in that world.

I predicted this consolidation of the dwarfs in the networking industry against the giant, Cisco. Another dwarf that is doing exceptionally well against Cisco is F5, which claims that it has a 90% win rate against the former in the niche market of application delivery controllers (ADC). According to networking and telecommunications researcher Dell‘Oro, the ADC market grew 10% in 3Q09 to $229 million. In the second quarter, F5 led the market with a 38% share versus Cisco’s 26%.

Let’s now take a look at the recent performances of these three networking players. Polycom reported its fourth quarter results last week. Q4 revenue was up slightly from $263 million last year to $268 million, and net income was $13 million or $0.15 per share, down from $26 million or $0.30 per share last year. Adjusted earnings were $0.42 per share versus analyst estimates of $0.31 per share on revenue of $256.4 million. For the full year 2009, revenue was down 9.5% to $967 million and net income was down 34% to $50 million or $0.58 per share. Q3 analysis is available here.

Polycom generated a record positive operating cash flow of $68 million and ended the quarter with $467 million in cash and no debt.

For the first quarter, Polycom expects revenue to be down 2% to 3% sequentially, above analysts’ expectations. However, it expects an operating margin of 11% as sales and marketing expenses are set to increase; this is much lower than analyst expectations. Full-year operating margin is expected to be 13% to 14%, and Polycom expects to meet its 20% operating margin objective in 2011. For 2010, the company forecast revenue growth in the high teens.

Polycom is trading around $23 with market cap of about $2 billion after hitting a 52-week high of $27.96 on October 1 after Cisco’s $3 billion offer for Tandberg. There was speculation that HP might acquire Polycom, but HP’s 3Com acquisition slowed that down.

Last week, Juniper Networks (NASAQ:JNPR) reported its fourth quarter results. Q4 revenue was up 2% y-o-y and 14% q-o-q to $941.5 million and net income was $131 million, or $0.24 per share. For the full year, revenue was down 7% to $3.32 billion and net income was $225.1 million or $0.42 per share. Q3 analysis is available here.

Segment growth was driven by strong contribution from new products, MX series service routers, SRX series service gateways, and EX series data center switches, which contributed over $236 million.

Gross margin was 66.9%, versus 65.8% last quarter and 67.5% last year. Juniper ended the quarter with over $2.6 billion in cash, and it repurchased shares for about $212 million in the quarter and $454 million in the year.

Juniper expects Q1 revenue to range between $880 million and $910 million versus analyst estimates of $873 million. It expects gross margins to be within its long-term range of 66% to 68%. Non-GAAP EPS is expected to range between $0.23 and $0.26. Juniper is currently trading around $25 with market cap of about $13 billion. It hit a 52-week high of $28.74 on October 23.

F5 Networks (NASDAQ:FFIV), the leader in the ADC market with annual revenue of $653.1 million, reported a strong first quarter on January 20. Q1 revenue was $191.2, up 15.5% y-o-y and 9.2% q-o-q. GAAP net income was $29.3 million ($0.36 per share) versus $21.4 million ($0.27 per share) in Q109. Excluding charges, earnings were $0.52 per share. Analysts expected earnings of $0.49 per share on revenue of $185.7 million. Q1 coverage is available here.

Results were strong across all regions except Japan. North America was especially strong, with revenue up 12% q-o-q and 24% y-o-y. EMEA was up 20% q-o-q and 15% y-o-y.

During the quarter, F5 generated $74 million in cash from operations and ended the quarter with $647 million in cash and investments. For the second quarter, the company has set a revenue goal of $195 million to $200 million with a GAAP EPS target of $0.36 to $0.38. The non-GAAP EPS target is $0.52 to $0.54. The stock is currently trading around $51 with market cap of about $4 billion after hitting a 52-week high of $56.19 on January 21.

The HP–3Com deal was clearly made with the aim to create an alternate front to Cisco. Another alternative could come from a Juniper–Polycom–F5 combination. Also, Brocade lingers as an independent vendor and could be pulled into the Juniper-led alliance. Finally, after years of domination by Cisco, the networking industry is seeing some exciting new alliances developing.

This segment is a part in the series : Networking Sector