I wanted to follow up on a prior blog post after attending a recent SDN conference where I also moderated an investment panel. In summary, I walked away from this conference and reading other recent SDN news thinking that 2013 will be a year of increased entropy for the SDN market. VCs will continue to fund new start-ups, incumbent large IT companies will announce SDN plans/roadmaps, users will demand open standards to avoid vendor lock-in and the press release and marketing onslaught will be intense. From an investment perspective, I still think it is too early to make any definitive conclusions given all this disorder and timing of SDN revenues being significant still being a couple of years away, but I believe that existing merchant silicon suppliers like Broadcom can only benefit from the deployment SDN with little threats from start-ups, while Layer 4-7 based appliance companies like F5 are most at risk given the ultimate SDN architecture and significant VC start-up funding in this area.
Users Want Open Standards: Not surprising, both enterprise and service provider end users are weary of being locked-in to single vendor or vendor coalitions. After all, one of the main goals of SDN is to unlock monolithic data center hardware and appliances to allow for more innovative and faster feature development. What I think will be challenging here is any standards efforts typically involves multiple constituents with different agendas. This tends to slow down the standards process and results in compromises in the ultimate standards that limit functionality and flexibility. A very relevant example in the recent past was the standardization process for IP Multi-media Subsystem (IMS) in the telecommunications industry. When I asked a senior technical executive from the telecom industry at the SDN conference on whether there were any lessons learned or best practices from the IMS standardization process that could be applied to SDN, the answer was not encouraging. Specifically, the executive mentioned how the standards process around IMS was tedious, took longer than expected, and resulted in compromises that ultimately left the standard somewhat inflexible for some future unforeseen requirements (e.g. certain aspects of machine to machine communications over 3G/4G wireless networks). Although not yet formally announced, the new open-source Daylight controller consortium from traditional networking and IT vendors Cisco, Citrix, HP, IBM and NEC will be interesting to watch. Is this is a true open-source initiative, or a coalition effort from those that benefit from the current processes in data center design, implementation and hardware sales that just want to keep the status quo as we transition to SDN over the next few years.
Fragmentation and Chaos: To me, the SDN market right now is both fragmented in terms of company functionality and chaotic in terms of vendor positioning and marketing. I say fragmented as most start-ups (and public companies for that matter) I see are offering one or a few pieces of the overall SDN solution, but not one is all that encompassing. That make sense given how broad SDN is both in terms of architecture and functionality. It is likely we will see continued funding of start-ups to fill in functions within the SDN functional grid as well as acquisitions as existing public companies and mature SDN start-ups seek to fill out their SDN offerings. The F5 acquisition of LineRate was a recent example of this as an existing appliance based Application Delivery Controller company F5, acquired an SDN start-up focused on Application Delivery Control. Thus, the fragmentation of the SDN market is likely to remain and supportive of continued VC funding, which will continue to fuel consolidation as mature start-ups, traditional networking, hardware and software companies seek to fill in the gaps of their SDN solution. I continue to believe such a cycle and the ultimate timing of significant SDN revenues being 3 years away will make it highly unlikely any true SDN start-up goes public in the next two years.
I also characterize the SDN market as chaotic right now given the marketing onslaught of large technology companies in 2013. In the past several days alone, we have seen initial indications of the open-source Daylight controller (e.g. expected to be supported by Cisco, Citrix, HP, IBM and NEC), SDN announcements from traditional vendors Ericsson and Huawei and ONUG releasing its top five recommendations to enable Open Networking. While 2012 was the year start-ups garnered virtually all the attention in the SDN market, 2013 seems to be the year that technology incumbents are scrambling for mind share through coalitions, product launches/roadmaps and acquisitions. On top of these developments, venture capitalists on the panel I moderated at the SDN conference indicated they expect further investments in 2013 for new SDN start-ups. Seems like the SDN crescendo will only intensify throughout the year.
Investment Thoughts: My investment thesis around SDN continues to evolve as I continue to digest new information. I provide some takeaways from the investment panel I moderated at the SDN conference below, which are of-course subject to change in the future as new information becomes available.
- Little Competition for Merchant Silicon Companies: Everyone agrees that there will be strong demand for merchant silicon for new hardware platforms as the SDN market develops. On the other hand, it appears VCs do not want to fund merchant silicon start-ups given the high R&D and other costs associated with semiconductor companies vs. software companies. Thus, my conclusion is that Broadcom and maybe Marvel (if they can get some traction with their merchant silicon products) could be companies to benefit from the growth of SDN, although it will take a few years for SDN to truly drive merchant silicon sales. Intel would be another beneficiary, but merchant silicon would likely be too small of a business for such a large semiconductor company.
- Layer 4-7 Companies More At Risk Than Cisco: While all incumbent data center equipment suppliers are potentially at risk from the future of SDN, I think special purpose appliance based Layer 4-7 companies like F5 are more vulnerable than Cisco. I say this because the ultimate SDN architecture will still require physical switching fabrics in the data center. Perhaps these fabrics will be merchant silicon based and Cisco will suffer share loss or margin pressure, but perhaps not. On the other hand, the stand alone Layer 4-7 appliance is not present in the future SDN based data center, but rather replaced by a pure software solution in the application layer. While its possible companies like F5 can pivot and transition their business models to be the suppliers of such software, the VC community seems intent on funding talented start-ups to attack this technology discontinuity while at the same time they are not funding merchant silicon companies at all and seem to be rarely funding data center fabric companies.
Disclosure: I currently own shares of Cisco, HP, Marvel and Ericsson mentioned in this report. I may currently or in the future solicit any company mentioned in this report for consulting services for NT Advisors LLC.