Networking Sector Laggards

According to Infonetics Research, the worldwide service provider switch and router market declined 5% in Q1 to $2.95 billion. Vendors such as Alcatel-Lucent and Ericsson reported revenue declines due to component and supply challenges. However, the North American market was up 29%, and Cisco increased its service provider router revenue by 33% from last year. Let’s take a closer look.

Alcatel-Lucent, (NYSE:ALU) the Franco-American telecommunications equipment company with annual revenue of €15.57 billion ($21.19 billion), said it saw demand strengthening in selective markets but was unable to meet this demand owing to tightening component availability. As a result, its first quarter revenue decreased 9.8% to €3.427 billion ($4.18 billion). Net loss was €515 million or €0.23 per share ($0.31 per ADS). It ended the quarter with a net cash position of €512 million. Q4 coverage is available here.

By operating segment, Networks saw a double-digit decline in revenue, partly owing to a shortage of components. Applications revenue declined 6.3% and Services revenue declined 3.1%. By region, revenue grew 6% in North America but declined 9% in Europe, 19% in Asia Pacific, and 23% in the rest of the world.

Alcatel-Lucent reiterated its outlook for 2010. It said that while its supply chain is still experiencing capacity constraints, the demand for telecommunications equipment and related services is recovering owing to booming data traffic and the need to increase network efficiency. It therefore expects nominal growth of 0% to 5% for the telecommunications equipment and related services market in 2010. The stock is currently trading around $2.42 with market cap of about $5.47 billion. It hit a 52-week high of $4.69 on October 7, 2009, and a 52-week low of $2.48 on May 7.

I have earlier hinted at major changes in the networking world as it consolidates. Alcatel after its $11.6 billion purchase of Lucent in 2006 has struggled to make a profit – it posted only two profitable quarters since the merger. CEO Ben Verwaayen says the company would be on the lookout to buy small startups to boost its portfolio. However, as it continues to grapple with the component shortages, some analysts have speculated that it could become a takeover target for Nokia Siemens Networks or a Chinese player.

Let’s now turn to the recent performance of another networking player, Brocade (NASDAQ:BRCD), a data center networking player with annual revenue of $1.9 billion. Brocade acquired Foundry in 2008 for $3 billion reported a 25% decline in its Ethernet business in the first quarter. However, in the recent second quarter, it reported a 2% y-o-y and 34% q-o-q growth in its Ethernet business driven by its federal sector, which grew 160% q-o-q. Its storage area networking (SAN) business, however, dipped this quarter by 4% y-o-y and 20% q-o-q. Brocade is the leader in the $2.4 billion SAN market and SAN accounts for more than 50% of its revenue.

Brocade, a data center networking player with annual revenue of $1.9 billion, recently reported second quarter revenue of $501 million, down 1% y-o-y and 7% q-o-q. Net income was $62.7 million or $0.05 per share, down 54.5% q-o-q and improving from a loss last year. The company ended the quarter with cash of $290.4 million and debt of $981 million. Q1 coverage is available here.

Last quarter, Brocade hired John McHugh, a more than 20-year veteran of HP ProCurve, as its new chief marketing officer; McHugh has outlined a go-to-market strategy with more involvement with non-OEM resellers.

Michael Klayko, CEO of Brocade, said, “Looking forward, we will continue to aggressively pursue the initiatives we have put into place to continue to drive sales of our Ethernet solutions to help meet our long-term goals for that part of our business. We are also encouraged by the apparent stabilization and recovery of IT spending trends globally that should help drive further momentum for our overall business in the second, and typically stronger, half of our fiscal year.” The stock is currently trading around $5.18 with market cap of about $2.3 billion. It hit a 52-week high of $9.84 on October 9.

Following its Foundry acquisition Brocade was seen as a potential threat to Cisco, but it hasn’t been able to live up to that expectation owing to poor execution. HP has been on an acquisition spree, picking up 3Com and Palm.

Overall, the networking sector has become vastly more exciting since HP’s move to acquire 3Com. With 3Com growing 40% inside HP, Cisco finally has a real competitor. Juniper continues to be an interesting company, and a Juniper–Polycom merger may be on the cards. That leaves Brocade and Alcatel-Lucent hanging. Brocade may yet find its way inside HP, but Alcatel-Lucent looks to me like the one that will finish last in this race.