The Tangled “Web” of Cisco, EMC and VMware

I recently wrote some articles on SeekingAlpha.com on the Cisco/EMC/VMware dichotomous relationship, Palo Alto Networks and Infoblox.  I have provided a quick summary and links to these articles below.

Cisco/EMC/VMware: I continue to be positive on Cisco stock and expect the company to formally launch its widely anticipated Insieme product at the Interop NY trade show in October.  CEO John Chambers will be keynoting at the Interop conference. I do not think John has done a keynote at an Interop trade show for many years, so it is likely Cisco wants to use this trade show as a platform to make a big announcement.  The launch of Insieme, the recent acquisition by Cisco of solid state drive storage vendor WHIPTAIL and the introduction of the NSX network virtualization platform by VMware at VMworld a few weeks ago continue to highlight the increasingly dichotomous relationship between Cisco and EMC/VMware.  I think Cisco and EMC/VMware will continue to promote their VCE partnership which has been successful to date, but at the same time seek to both be the leading player in the virtual and physical domains of the emerging next generation software defined data center.  At some point, one has to question when one of these companies makes a strategic move that could truly threaten the VCE relationship.

Palo Alto Networks:  While Palo Alto Networks remains a high growth company and leader in the security market, I am not positive on the stock given its high valuation, the low growth nature of the overall security firewall appliance market and the beginning shift in security spending towards cloud based security solutions.  Palo Alto does have a cloud based product called WildFire, and thus could capture a good part of the shift in security spend. To me, the success or lack of success of WildFire will be the main catalyst to watch for the stock in the longer term as well as the ultimate outcome of its ongoing litigation with Juniper Networks.  As a side note, I also was not a big fan of the company’s decision to exclude its legal expense related to its ongoing litigation with Juniper from its pro-forma guidance.  To me legal expenses related to lawsuits, inventory write-downs etc. are part of ongoing operations and should not be excluded from pro-forma results.  Obviously, there are many different opinions on this topic and I am sure Palo Alto had some valid reasons whey they chose to exclude the legal expense from their guidance.

Infoblox: I have been positive on Infoblox given it has a leadership position in a unique niche in the automated network control market and is seeing new product success via their DNS firewall security product.  DNS cyber attacks are becoming more prevalent, which could set the framework for increased awareness and demand for the Infoblox DNS firewall.  The stock, however, has had a significant appreciation this year and at this point the valuation probably does not support significant upside from these levels.

Telco Capex, Big IT War Chests and Optical Component Stocks

I have been traveling quite a bit these past couple of weeks and working on some consulting projects, but wanted to provide a quick update on topics I have been writing about in the past few months.

Telco Capex:  As a continuation of prior blog posts since November of last year, I continue to believe telecom capital spending trends will be positive in 2013 and the momentum still remains positive.  Telco operators are often like Wall Street in that they follow the “herd mentality”, namely, they tend to follow each other in either being offensive or defensive in their respective spending plans.  The setup for a favorable capital spending cycle in 2013 seemed good given the challenging 2011 and 2012 spending environment led to a period of underinvestment going into the build-out cycles associated with LTE, Data Center connectivity and residential broadband upgrades.  While 2011 and 2012 were years of preservation of capital and a defensive posture, 2013 and perhaps 2014 will be years where telecom operators go on the offensive by investing in new technologies in an attempt to gain share and offer new services.  I have already written about how we have seen such offensive moves in the US (e.g. AT&T and Sprint) and Europe (KPN, Telecom Italia, and DT).  Last week, we got the important endorsement of this trend from China Mobile, the wireless operator with the largest wireless capital spending budget in the world.  China Mobile announced its 2013 capital spending budget will be up 49% over 2012, well above analyst expectations of a 23% increase.  I continue to be favorable on telecom equipment stocks given this ongoing positive momentum in capital spending in 2013 and view Ericsson as a reasonable way to play this cycle.   It is important to realize here, however, that most telecom equipment stocks are cyclical, not secular, stocks. Ericsson is up over 50% from the bottom and is already discounting the recovery in telecom capital spending. The “easy money” likely has been made in the stock, although I still think there might be another 10%-20% upside from here.

Big IT War Chests: This past week Salesforce.com raised about $1B through a convertible note while EMC/VMWare announced plans to IPO their Pivotal Big Data/Cloud initiative sometime in the future.  I view both of these events as ongoing evidence how Big IT companies (e.g. Cisco, IBM, Oracle, EMC/VMWare, etc…) are gearing up for an M&A cycle to better position each of them in the battle for Everything Cloud (e.g. Big Data, SDN, Data Center Virtualization etc…).  Salesforce.com already has about $1.8B in cash/investments and generates over $500m a year in free cash flow. The company also has a very high PE multiple of almost 90x 2013 earnings.  Acquisition targets, especially private companies, may find taking Saleforce.com stock as too risky given the high multiple and would prefer cash.  I believe Oracle’s recent acquisition of Eloqua (announced in December) perhaps accelerated Saleforce.com’s desire to have a greater cash balance to have a greater war chest for future acquisitions. In order for Saleforece.com to compete for such acquisitions against more cash rich companies like Oracle, Cisco etc…, they needed to increase the cash balance.  EMC/VMWare on the other hand have the other problem.  In the past, VMWare provided EMC a high multiple currency to make stock based acquisitions, while EMC and VMWare both have had ample cash to make cash based acquisitions. The recent selloff in VMWare stock post reporting 4Q12 results, however, lowered VMWare’s forward P/E multiple to about 20x vs. the historical average of about 35x-40x.  The announcement of the potential IPO of Pivotal in the future helped both stocks and ultimately will provide EMC/VMWare another high multiple stock to make stock based acquisitions.    With Cisco aiming to be more of a software company, Oracle trying to expand more in the telecom space (e.g. Acme Packet acquisition) and all the Big IT companies striving to be leaders in Big Data, SDN and Everything Cloud, we are likely to see an increasing M&A cycle in 2013 and 2014 and these companies are getting their respective war chests ready.

Optical Component Stocks: Silicon Photonics vs. The Cycle: In a prior blog post, I expressed some concern on optical component stocks (e.g. JDSU, FNSR etc…) given the technological threat posed by the emerging Silicon Photonics technology.  I am still concerned about how Silicon Photonics initiatives at Intel and others as well as vertical integration efforts by large buyers of optical components like Cisco (through the acquisitions of CoreOptics and Lightwire), will impact future valuations and stock performance of optical component stocks.  While I still have this concern, the near term cycle of optical spending is likely to trump the longer-term risk of Silicon Photonics in my view.  In a way, Silicon Photonics will be to optical component stocks in 2013 like SDN was to networking stocks in 2012.  As a reminder, Cisco’s stock suffered in 2012 as SDN became a hot topic and VMWare acquired network virtualization specialist Nicira.  While SDN is still a hot topic, Cisco’s stock has performed well in the past several months as the company has beaten estimates, preserved its gross margin and SDN is not viewed a near term threat.  I think the optical cycle is recovering and we should see good spending trends in optical systems and components in 2013, as 2013 will likely be a recovery year after a difficult 2012. In addition, telecom capital spending trends continue to show positive momentum in 2013 as I mentioned above.  Thus, while there will continue to be a lot of discussion and analysis on how Silicon Photonics will impact optical component suppliers in the future, 2013 should be a year where optical companies beat Wall Street estimates.  I think such a playbook will allow optical stocks to further appreciate for a few more months.  Like telecom equipment stocks, optical component stocks are cyclical and they all have already appreciated significantly off the bottom.  Thus, upside from current levels may be limited and the stocks remain very risky and volatile. We should get further information on the status of the optical cycle and the threat of Silicon Photonics this week at the annual fiber optic OFC trade show, which I plan on attending.

Disclosure: I currently own Ericsson and JDSU mentioned in this blog.  NT Advisors LLC may currently and in the future solicit any company mentioned in this blog for consulting services.

Oracle and Cisco On A Collision Course

Today Oracle announced it was acquiring session border controller equipment supplier Acme Packet for about $1.7 billion.   Acme Packet has roughly 50% market share of the $500 million session border controller market.  What I find interesting in this strategic move by Oracle is that they are entering a market (albeit a relatively small market) that is served by traditional communications equipment suppliers like Cisco, Alcatel-Lucent and Ericsson.  One has to ask, why is Oracle entering such a market?  My view on this is Oracle sees that the combination of high speed public roaming wireless technologies like LTE, the maturation of IP Multi-Media System (IMS) for IP service manageability (which SBC is a part of), more sophisticated mobile devices (e.g. tablets and smartphones) and cloud hosting as allowing for the first time communications service providers (e.g. Verizon and AT&T) to truly offer a full suite of managed fixed and mobile services to the enterprise customers.    Oracle wants to be a solution provider to service providers and large enterprises in the areas of business/services operations, IMS core manageability and application creation elements.  Oracle already does a significant amount of business with service providers in business/services operations and is likely looking to expand its offering in IMS core and application creation.  Acme fits into the IMS core.  I would not be surprised to see Oracle acquire Layer 4-7 application companies within the Software Defined Networking (SDN) architecture as well to enhance their offerings in application creation.  These companies, however, may not necessarily be public companies, but rather private start-ups developing pure software applications rather than special purpose network appliances.

What is also clear to me in this move by Oracle is how Cisco and Oracle will become more competitive over time. This is not surprising, as both companies are somewhat mature and seeking new growth vehicles.  What probably also accelerates this increasing competition between the two companies is Cisco’s recent strategy shift to being more of a software company.  Acme was a main competitor to Cisco, albeit in a small market of only about $500 million.  Even so, this deal likely portends of more competitive clashes between the two companies in the future.  So while the street has been focused on the increasing competitive dynamics between EMC and Cisco after VMware acquired Nicira back in July of 2012, now we can add another competitive battle with Cisco in the form of Oracle.

Large cap technology companies like IBM, Oracle, Cisco, EMC and HP all are mature when one looks at single digit organic revenue growth or even less for IBM and HP.  We are likely to see more of these technology titans continue to compete with each other as we have already seen in the past several years.   Even though this is obvious, predicting the actual M&A decisions by each company has not always been so obvious.  While VMware acquiring Nicira was not too shocking, I don’t think many were predicting Oracle would buy Acme Packet.  More such surprises are likely in 2013 and beyond to the point one has to question how the networking equipment industry landscape will look like in a few years.

Disclosure:  I currently own shares of Cisco and Ericsson mentioned in this blog post.  NT Advisors LLC may currently or in the future solicit any company mentioned in this blog post for consulting/advisory services.

Cisco Wants To Be #1 – Déjà Vu All Over Again

Cisco held its annual financial conference on December 7th and as expected, the company outlined its new plan to become more of a software and services company. I wrote about this twist on Cisco’s strategy on my blog “Cisco Pulling an IBM?” on November 19th.   While Cisco spent a good part of its analyst day talking about how it is best positioned to implement this new strategy, CEO John Chambers also put out the goal for Cisco to be the number one IT company in the world in the future.  What I found interesting about this statement is that Cisco first put this target out in the 2006-2007 timeframe in a prior financial analyst meeting.  At that time, Cisco had its “secret” spin-in Nuova developing the UCS blade server allowing Cisco to expand its addressable market within the IT industry from networking to also servers.  Cisco was also at that time initiating its entry into the consumer IT segment, which it later shutdown in 2011 post the failed 2009 acquisition of Flip maker Pure Digital.

Cisco backed off its aim to the be the number one IT company when the 2008/2009 recession led to a decline in Cisco revenues and earnings, and concern that HP was going to commoditize its traditional networking business hit the stock in 2010/2011.   Well now that the great recession is over and HP is viewed less likely to be a challenger to Cisco given the numerous problem the company is experiencing, John Chambers has re-launched the bold target to be number one.  In 2006/2007, Cisco had the expansion into servers and the data center market as its launch pad for being more than just a networking company.  Today, Cisco is using a more aggressive entry into software and services as the next frontiers for being number one.  Storage seems to remain an area of partnerships rather an acquisition for now, but that could change depending on what EMC decides to do in the future with regard to any broader efforts in the networking market.

In my view, Cisco is better positioned in the networking industry than it was a couple of years ago as primary large competitors HP, Huawei and Juniper are less of a threat.  HP has had many corporate issues and a failed overall strategy to date, Huawei’s success in entering the Enterprise market has shown little progress outside of China and Juniper is spread thin and faces niche competitors in addition to Cisco in areas such as security and switching.  The improved competitive standpoint in networking and a much stronger commitment to capital returns to shareholders via a higher dividend yield than the past has make Cisco stock a safer place to be these days than the past three years.

While Cisco stock may be safer today than in the past three years, I think its still a long shot for Cisco to fulfill the number one IT company goal given IBM is basically already the de-facto number one IT company today with a strong suite of software and services, trust by corporate CIOs and a very focused and consistent strategy.  I don’t see IBM bowing to Cisco’s new goal to be number one.  In addition, other large traditional IT companies like Oracle and EMC and new challengers to the traditional IT model like Amazon, Apple and Google are all aiming to capture a larger share of corporate IT spending.  So until proven otherwise, Cisco’s claim that it wants to be number one in IT sounds like déjà vu all over again to me.  Given John Chambers is likely to retire within the next 3-4 years, the ultimate outcome of this goal is not even likely to be known when he departs after a long and successful role as CEO since 1995.

 

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?

 

 

 

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….