Will Cable TV Stocks Continue to Outperform Post the AT&T Analyst Day?

Well hurricane Sandy continues to pound my neighborhood and while my standby gas generator continues to keep the lights on, a large tree just fell in front of my house.  Check out the picture below. Luckily, no one is hurt.  So with everyone safe and not much else to do, I wanted to share my thoughts on whether or not the upcoming AT&T analyst day will impact the future stock performance of Cable TV operators and AT&T broadband access equipment suppliers like Adtran, Alcatel-Lucent and Ciena.

Hurricane Sandy Hits Home

Sometimes, the performance of a stock or industry can be determined by a significant change in the competitive landscape. The performance of leading Cable TV stocks Comcast and Time Warner Cable over the past several months I believe is a case in point.  Since December 1st, 2011 Comcast and Time Warner Cable stock prices are up over 60% while the S&P 500 has only gained about 13% over the same period.   What happened to the competitive landscape after December 1st 2011 that led to such a strong outperformance of the Cable TV stocks?  Simple, Verizon announced it was purchasing the wireless spectrum owned by Comcast, Time Warner Cable and Bright House on December 2nd, 2011.  In addition, both AT&T and Verizon in 2012 have reduced their respective spending on their wireline networks as they dramatically shifted their capital spending and strategic business development towards the expansion of their respective wireless businesses.   Basically, Cable TV operators kept focusing on what they do well, namely, residential triple play while AT&T and Verizon were both in a hunt for obtaining spectrum in a manner acceptable to the FCC/DOJ and in a race to see who can build out a 4G LTE network the fastest.

The question now becomes, will this favorable competitive dynamic continue into 2013.  I think we will get part of the answer to this question at the upcoming AT&T analyst day scheduled for November 7th.  The press and analyst community has written about how AT&T is contemplating upgrading millions of rural access lines with higher speed broadband technology.  A decision is likely made public during this analyst meeting.  In addition, industry people have suggested that AT&T may be also considering a more comprehensive broadband initiative for 2013 that will also target the small medium business market to fend off an increasing effort by the Cable TV operators in this segment of the market.

A renewed focus by AT&T on rural broadband and being more aggressive against Cable in the SMB segment, could cause a shift in the favorable competitive dynamics Cable has seen since December of 2011. This could put some pause, at least temporarily, in the strong outperformance of the Cable TV stocks.  Also, if AT&T was to indicate a new rural broadband spending plan and more spending to fend off Cable in the SMB market for 2013, it could cause a bounce in the Broadband Access and Metro Ethernet equipment suppliers that supply to AT&T such as Adtran, Alcatel-Lucent and Ciena.

Riverbed Opts for More Network Management

On a very stormy day on the East Coast where my newly purchased standby gas generator is keeping my computer and lights humming, I had some time to listen to the conference call today where Riverbed announced its plans to acquire Network/Application Management company Opnet.  My quick take on this deal is that Riverbed is making a bold move to double down in the tangential market of Network/Application Management, but the Street is likely to take a wait and see approach on how they execute on this strategy.  I think owners of the stock were looking for a strong product refresh cycle in its core WAN Optimization business.  The story just changed, with the ultimate outcome unclear.  While the stock had a nice upward move after a good 3Q result, it likely stalls in the near/intermediate term in my view.

Overall, I can see why Riverbed is doubling down on Network and Application Management, building on its small but rapidly growing Cascade business.  Namely, the traditional WAN Optimization business that forms the vast majority of Riverbed’s sales and the core of the company is now growing slightly less than 10%.  In order for Riverbed to sustain longer-term growth of 15% or more (an unofficial metric to be perceived as a reasonable growth company in the technology industry), Riverbed needs to expand into new markets.  Since the early acquisitions in Network Monitoring/Management over the past three years are finally putting up solid growth of over 30% as Riverbed gains share, why not double down and try to be the market leader in this overall market that is very fragmented.

Riverbed dabbled in networking monitoring/diagnostics via its acquisition of Mazu back in early 2009.  It then added the acquisition of CACE in October of 2010.  These two deals, however, were closely linked to the core WAN Optimization business as the respective diagnostic/monitoring products were primarily focused on determining need and how to best deploy WAN Optimization appliances within an Enterprise.   With the acquisition of Opnet, Riverbed is dramatically expanding within the Network and Application Management market as Opnet’s products offer more broad performance data than just the WAN Optimization application.

While attending Interop NY in September of this year, I thought that the Network Monitoring and Diagnostic industry would see convergence between Test/Diagnostic companies like Ixia and JDSU and Networking/Application Management companies like Opnet, Gigamon etc…  With Ixia acquiring BreakingPoint Systems in July of this year, I had though we would see further consolidation of the entire test equipment, diagnostic, monitoring and management segments given how fragmented these industries have become.  I even thought JDSU would respond to Ixia’s acquisition of BreakingPoint and consider a larger deal in this market.  So, Riverbed’s move is not surprising given they were a niche player in the market, but one that was not so obvious to me a couple of months ago.

Tucci Says “No” To Networking; Chambers Says “Yes” to Software

While reading a few earnings releases today and listening to a couple of earnings calls, two items stuck out to me from a strategic standpoint that I thought were interesting.   In particular, it seems more likely that Cisco will acquire software companies in the future rather than EMC/VMW acquiring hardware based networking companies.  

As discussed in a prior blog post, I did not think EMC would acquire Juniper even with VMware acquiring Nicira.  Well today on the EMC earnings conference call, Joe Tucci put a nail in the coffin regarding the EMC/Juniper speculation when he went out of his way in his prepared remarks to say EMC will not acquire a hardware networking company and that the VCE partnership with Cisco remains important and strategic to EMC.

Even though it was likely that Cisco competed with VMware for the acquisition of Nicira, the fact that VMware prevailed does not necessarily imply that EMC/VMware also want to enter the actual hardware element of data center networking.  Nicira is a Software Defined Networking (SDN) company that operates in the control plane layer of the SDN hierarchy.  It is a pure software company whose business model mirrors that of VMware, thus, the two together make a lot of sense (although the price paid for the acquisition is another story).   Going down the stack in the SDN hierarchy into the actual data plane where Cisco, Juniper, Arista, Brocade and others reside is not a necessary or smart outcome for VMware in my view.  So, kudos to Joe Tucci for drawing a line in the sand and staying out of a market segment he could continue to partner for today and in the future when SDN becomes more prevalent.

The other interesting item I saw today was an excerpt from an interview by Gartner of John Chambers, CEO of Cisco in Network World Magazine.  The excerpt is as follows:

 “We are going to move on multiple fronts with software,” Chambers said. Cisco’s goal is to double software revenue over the next five years, Chambers added. “The industry is set up for an open software player that integrates with every device.”

Typically when John says he wants to double revenues in an area that is small for Cisco, it typically means acquisitions.  Over the years the two companies I have heard people in the industry and press discuss the most often as potential software acquisition candidates for Cisco are BMC and Citrix.    Both are probably unlikely in my view right now.  Even though BMC has been reported by the press to be actively looking for strategic buyers, and its Enterprise Value of about $6B and forward P/E of about 11x put in the reasonable size range for Cisco, I doubt Cisco would acquire BMC as it would likely be viewed as “too legacy” of an acquisition.  Cisco needs to figure out how to get out of the low single digit organic growth rate and acquiring BMC would likely not help in that regard.  While Citrix would be a more appropriate strategic fit for Cisco given it fits it in well with Cisco’s Virtualization and Data Center priorities, Citrix has an Enterprise Value of about $11B and a forward P/E multiple of about 20x.  Add to that current valuation a reasonable take out premium of at say 20-25% and you have an expensive acquisition.  Cisco also has never acquired a company so large either in absolute market capitalization or as a percentage of its market capitalization. So while Citrix would be a nice fit, probably too big/expensive for Cisco to pursue right now.

So if not BMC or VMware, then who?  There is a multitude of small (public and private) and mid-size software companies that Cisco could pursue so guessing the right one is not easy.  In the telecommunications market, one that seems like a reasonable logical and size fit is BroadSoft. The market capitalization of about $1B and complementary aspects to Cisco’s unified communications focus would make this possible in my view.  Anybody have any other ideas on who Cisco might acquire in Software?




Juniper Stock Seems Stuck

After reviewing Juniper’s 3Q earnings release and listening to their earnings call tonight, I came away continuing to think that Juniper’s stock is stuck in many ways.  In particular, the company seems to be bound to single digit revenue growth at slightly over $1 billion in quarterly revenues and a peak quarterly run rate of $0.20-$0.25 in pro-forma earnings per share.   In the world of technology stocks, former darling growth companies that seem stuck in terms of revenue growth and peaking earnings power suffer the ongoing melting away of their valuation multiple. Clearly Juniper has seen their valuation compress over the past several quarters, but hopes of an expanding multiple do not seem likely for now.   With earnings bound  between $0.80 and $1.00 on an annualized run rate, the stock is not likely to get over $20/share in my view anytime soon.

The key for Juniper’s valuation expansion will be acceleration of its revenue growth and margin preservation. While new products like the PTX in MPLS Core Switching and Q-Fabric in Data Center Fabrics have provided hope to the Juniper bulls on the stock over the past year or so, these products continue to ramp very slowly.  There also continues to be doubt on how successful the Q-Fabric product will be given its lack of significant revenue traction in the past few quarters, increasing competition in this segment of the market and the potential overhang that the open standards Software Defined Networking (SDN) architecture poses to the originally closed Q-Fabric offering.  Juniper mentioned on their call that SDN is a key area of focus for the company, and it is likely the company will focus its efforts in the future to make the Q-Fabric more open and less reliant on the originally planned closed Juniper Q-Fabric controller.

There also continues to be a lack of excitement in the future growth prospects of the traditional Router and Security businesses.  Both Routing and Security products have shown year over year declines for the nine-month period through the end of 3Q12.  One could argue somewhat convincingly that routers are suffering a cyclical decline and are poised to recover at some point, but even so, the future growth is likely to remain sub 10% in the future.  Security is not suffering any cyclical decline, but rather a case of niche specialized competitors gaining share (e.g. Palo Alto Networks, Fortinet etc…) as Juniper has lost competitive advantage in this market.  \ It is unlikely this business will return to a consistent growth story in the future.  The company continues to do well in the traditional enterprise Ethernet Switch market growing 20% year to date vs. last year, although this business tends to be lower in margin profile than both routing and security, thus, not likely to help the long term business model.   Even so, this is the one share gainer Juniper has going for it right now.

What Should Juniper Do?

Juniper is in a multi-front war in Service Provider Routing, Enterprise/Data Center Switching and Next Generation Security Firewalls all of which will also be challenged in some unknown way by the emergence and deployment of SDN in the next 3 years.  The status quo of investing in all of the above seems like a high risk proposition for Juniper as it will have to continue to fend off much larger companies like Cisco and Huawei and smaller product specialists like Arista Networks, Palo Alto Networks etc…  My sense is Juniper will need to focus more, get back to its roots in the Service Provider market and seek larger committed partners that can help it succeed in the Enterprise market.  Breaking up the company while likely very difficult could also be a favorable outcome for shareholders as different buyers would emerge for the Service Providing Router business and the Enterprise business.

EMC/JNPR? Seems A Long Shot To Me.

In the past week I have read press articles suggesting EMC might be considering an acquisition of Juniper Networks.  It seems today the potential for this deal happening has made its way into the financial markets and is now impacting the stock price of Juniper.  While I can see how the ongoing rift between Cisco and EMC over the past few months (e.g. EMC/VMWare acquisition of Nicira, Cisco’s funding of start-up Insieme, Cisco’s expanded partnership with Citrix etc…) could lead some to conclude that EMC wants to further take it to Cisco by acquiring its primary networking competitor Juniper Networks, I think such a deal is a long shot.  In particular, I think that if EMC wanted to add Ethernet Switching to its Data Center products and move away from Cisco for such products, it would be more practical for them to consider less complicated acquisitions such as Arista, Brocade and others that are smaller in size and more focussed on the Data Center Ethernet Switch market.  Juniper on the other hand derives the majority of its revenues and vast majority of its profits (and likely its current value as a company) from its Service Provider Router business.  Does EMC want to be a Service Provider router vendor?  What would EMC do with the struggling Security business at Juniper?   So while there is always a chance such a deal could happen and the rift between Cisco and EMC moves towards all out war, I just don’t see it happening….

Is Alcatel-Lucent The Next Nortel (or Motorola)?

Is Alcatel-Lucent going to the way of Nortel (i.e. bankruptcy) or Motorola (i.e. breakup)?  It is likely that Ben Verwaayen and the Alcatel-Lucent Board of Directors are certainly thinking about this as they prepare to share more details about the restructuring plan initially announced on July 26th of this year.  These details are likely to be shared with the financial community when the company reports its 3Q results on November 2nd or sometime soon thereafter.

Alcatel-Lucent and Nortel (and to some degree Motorola) were legacy telecom equipment suppliers that suffered from three issues since the 2000 tech bubble collapse:

1)   The market entry and vast success of China based Huawei with its significantly lower cost business model

2)   Service provider consolidation, which dramatically reduced the number of customers and created a smaller group of much larger customers (e.g. Verizon = NYNEX, Bell Atlantic, GTE, MCI, WorldCom, UUNET, Alltel etc.….)

3)   Pension obligations, which further impacted their cost structure vs. newer competitors that did not have this overhead

For Alcatel-Lucent to avoid being the next Nortel, and salvaging some value for shareholders and likely more jobs for current employees longer term, I believe the proper course for the company should be to break itself up like Motorola did rather than risk a bankruptcy process to lead to such a break-up.  While there are many outcomes for such a break-up, we believe the best choice for the Company is as follows:

1) Sell Mobility and Mobile Patents to Samsung or Cisco:  While the trend towards Mobility is a convincing reason for Alcatel-Lucent to stay in the wireless infrastructure business, the company does not have enough scale vs. other businesses like IP Routing and Optical.  The rapid decline of legacy high margin CDMA technology also makes the wireless business likely loss making now and into the future.  Given US security concerns as evidenced by the recent US review of Huawei and ZTE, I believe this business could only be sold to a “Western friendly” company. Samsung makes the most sense given its already in the wireless infrastructure business (but lacks scale), has strong financials, can complement its strong mobile handset business and would welcome additional intellectual property in its ongoing patent war with Apple.  While Cisco is a longer shot given its lack of historical desire to be supplier of base stations (although it did try and fail to enter the WiMax market via an acquisition in the past), its ability to garner more presence with leading global services providers could make such a transaction somewhat enticing.    Hey, if Cisco acquired Scientific-Atlanta, why not think about them considering the Alcatel-Lucent wireless business if it went up for sale?

2) Double Down On IP Routing and Optical:  Where Alcatel-Lucent has scale, competitive technology and better prospects for profitability in my view is in the IP Router and Optical Systems market.  The company is number two globally in edge IP Routers and in the top two in Optical Systems.   The ongoing convergence of IP and Optical also provides unique competitive positioning.  While the company does have global scale in the Broadband Access market, there is little or no growth in this business going forward.  The company should likely stay in the business with a transition to more of a services/OEM model by utilizing more focused vendors in this market for future upgrades of the installed base.

3) Jettison the Enterprise Business: The Alcatel-Lucent Enterprise business is competitively in a weak position with little if any product leadership and lack of scale.  According to the company’s financial reports, the business is still generating a small profit.  I believe divesting this business and letting it fend for itself is the best outcome given it has little synergies with the service provider business and creates little or no value within the overall company.  Its not clear the Enterprise business would compete effectively as a stand alone company, but given management was not able to find a buyer for the unit over the past several years at any price, there is nothing to lose letting it go its own way.

Well those are my thoughts, lets see what Ben and team decide to do.