Is Cisco Investing in C-RAN?

While most Cisco investors will be primarily focused on the company’s official launch of the Insieme Nexus 9000 data center product on November 6th and the company’s earnings report on November 13th, I wanted to share my opinion on what Cisco may be working on to disrupt the traditional wireless infrastructure market.  CEO John Chambers recently made some bold statements in an interview with Barron’s stating that Cisco has invested in a start-up as part of the company’s disruptive plan to enter the traditional wireless infrastructure market currently served by Alcatel-Lucent, Ericsson (ERIC), Huawei and Nokia Solutions and Networks (NOK).  My guess as to what Cisco is considering for this disruption is Cloud-Radio Access Network (C-RAN) technology.  In theory, C-RAN technology aims to centralize (“in the cloud”) the baseband processing done at each cell site base station in wireless networks resulting in a more optimized utilization of baseband resources.  In addition, C-RAN facilitates joint processing and scheduling between various cell sites allowing for reduced interference, increased throughput and improved performance of the network. C-RAN also supports less energy consumption, which would support Cisco’s sustainability efforts and a more environmentally friendly deployment of wireless networks.  C-RAN also fits the Software Defined Networking (SDN) and Network Function Virtualization (NFV) framework, which Cisco aims to exploit for new revenue streams.  Commercial deployment of C-RAN technology is probably at least a couple of years away, but given the traditional wireless infrastructure market which Cisco does not current play in is $40+ billion in size, and the company has already made $2 billion of wireless acquisitions in the last year in other segments of the wireless market, it would seem the logical path for Cisco to try to enter the wireless market.  Time will tell what Cisco actually is planning for entry into the wireless infrastructure market.

For more information on the topic of Cisco potentially investing in C-RAN technology and my current thoughts on Cisco’s stock, please visit my recent article on seekingalpha.com.

 

 

 

What To Do With ALU?

In prior blog posts over the past few months I have been positive on technology stocks for 2013 given low relative valuations to the overall market and my view that IT and telecom capital spending will recover in 2013.  In particular, I have liked Alcatel-Lucent and Ericsson as a play on telecom capital spending and increased concern over Huawei as a security threat in the US (and some other markets), and recently Hewlett Packard given extreme negative sentiment, favorable cash flow and a low valuation, which was amplified by the Dell LBO valuation metrics.

While I remain positive on technology to outperform this year, Alcatel-Lucent has become a bit more challenging of a stock in my view.  I think the stock could still work over the course of the remainder of 2013, the next 2-3 months could be volatile and the stock could decline until after 1Q13 results are reported.  I base this on the new dynamics that have become public since the company reported 4Q12 results on February 7th, namely:

–       A new CEO was announced and he will not take over until April 1st, thus, potentially distracting the company during this interim period in 1Q13 as well as the new CEO potentially resetting expectations lower given new CEOs often seek to “lower the bar” when they take over a struggling company

–       Press reports about a potential combination with competitor Nokia Siemens Networks (NSN), which in theory could be positive but in reality may be very difficult to implement and execute

–       Press reports that the French government may take a stake in ALU to help secure the future of the company and its patent portfolio, which I think would not be in the best interest of shareholders

Positive on New Executive Announcements

I think the new CEO selection of Michel Combes seems like a good one given his background in the telecommunications industry at Vodafone and France Telecom and more importantly his reputation as a cost cutter, which is what ALU needs the most right now.  I think it is also positive that a new CEO was selected quickly, rather than long drawn out process.  I believe he will be well received by investors when he takes over the company on April 1st.  In addition, I strongly favor the selection of Jean Monty for the new role of Vice Chairman of the Board of Directors. When I was a Wall Street analyst, I found Jean Monty as an excellent CEO as he led the turnaround of Nortel in the 1990s after Nortel had underinvested in R&D and was suffering market share loss and degrading customer relationships.

While I am positive on the two new executive announcements, this first quarter could be a very challenging one for ALU.  The new CEO does not take over until April 1st.  The company could lack focus on trying to deliver the best financial results as possible given uncertainty on what the new CEO will do when he takes over on April 1st.  In addition, the first quarter of every year tends to be the most challenging for ALU and in the industry as a whole.  Thus, there could be some pressure on ALU shares until 1Q13 results are behind the company in my view given these transitory issues.

 Merger With NSN Good Theory, But Probably Difficult in Reality

The press has reported that ALU may be seeking a merger, investment or some other partnership with European competitor NSN. In theory, a merger with NSN might look attractive given both ALU and NSN are competing against much larger wireless infrastructure suppliers Ericsson and Huawei.  Combining forces would reduce competitive pricing pressure and provide more scale to compete against these two larger companies.  In reality, however, merger of equals in the telecom infrastructure usually results in 2+2=3, not 4 or 5.  The reason is that rationalizing duplicative product lines (wireless infrastructure in this case) is not easy, as customers do not typically accept products to be discontinued due to a merger. Thus, duplicative products and associated costs linger much longer than anticipated.  The other main issue in merger of equals is the cultural clashes of the two companies and political infighting that take place post the merger.  In fact, both NSN and ALU experienced these issues when each entity was formed in prior mergers (i.e. Alcatel merging with Lucent and Nokia Networks merging with Siemens infrastructure).

In addition to the challenge of achieving synergies being difficult in a merger between ALU and NSN, the appetite of NSN to go through such a restructuring effort after it is far along on its own restructuring plan would seem low to me.  NSN is well along in its restructuring into a primarily wireless infrastructure company after selling most of its other businesses and downsizing the company’s workforce by close to 25% (e.g. Access business sold to Adtran, Optical business sold to Marlin Equity Partners, Microwave Transport to DragonWave and Business Support Systems to Redknee etc.).  These restructuring efforts have paid off for NSN as it has reported solid financial results in 2012.  Merging with ALU would require a long merger process followed by another couple of years of new restructuring.

Another problem in merging NSN and ALU is that NSN is not a public company and does not have its own stock.   It seems to me that NSN, if public, would have a higher valuation than ALU and be more of the potential acquirer or investor into ALU than ALU being the acquirer or investor into NSN.  NSN is much further along than ALU in its restructuring, and as a result is much more profitable than ALU with full year 2012 operating margin of 5.6% and 4Q12 operating margin of 14.4% vs. ALU full year operating margin of (1.8%) for 2012 and 2.9% for 4Q12.  In addition, NSN has been generating positive cash flow for the past several quarters while ALU burned cash in 2012.  The better profitability, cash flow generation and further restructuring progress at NSN, would likely result in a higher valuation for NSN than the current ALU valuation.  ALU currently trades at about 0.3x EV/Sales. Ericsson, the other global, large, profitable and publicly traded telecom equipment supplier, currently trades at about 1x EV/Sales. My sense is NSN would trade closer to the valuation of Ericsson rather than ALU (maybe 0.6x-0.7x EV/Sales as an estimate).

Given NSN would have the higher valuation than ALU, but does not have a public stock currency, either NSN would first have to be spun out as a stand alone company to obtain a stock currency or NSN parent companies Nokia and/or Siemens would have to put up the cash to acquire ALU.  A spinout is certainly a possibility, but that will take months to implement and it would be highly unusual for such a spinout to do a large acquisition right after the spinout.  I also think neither Nokia nor Siemens has the appetite for using their cash to acquire ALU.  In particular, I think Siemens no longer views telecom infrastructure as strategic and would be reluctant to provide any additional cash infusion to NSN so it could acquire ALU.  Siemens is more likely looking at monetizing its potential stake in NSN (e.g. about €4-€5 billion) rather than investing more into the JV to acquire ALU.  Nokia may want to maintain an ownership in NSN even post an spinout given there are some advantages in selling both mobile devices and infrastructure to telecom operators. Huawei is using this tactic more often, and I believe Nokia views NSN as a way of countering this Huawei sales approach.  There may be some other intricate financial means for NSN to acquire ALU than the two I mentioned above, but regardless of the method, it would be a challenging integration in my view.

French Government Involvement Not Likely In Shareholders’ Interest

Press reports also suggest the French government may seek to invest directly in ALU via the government’s Strategic Investment Fund.  This fund was used in the past to invest in other French based companies (e.g. Gemalto and Nexans SA) that the government viewed as critical to French competitiveness. I am not positive on a French government investment in ALU.  I think a key motivation of the French government to invest in ALU would be for job preservation in France (ALU employees about 9,000 in France), which would oppose the whole idea around cost reduction for ALU and not be in the best interests of shareholders.  For shareholders, I think it would better to see ALU go through a restructuring program much like NSN did over the past two years, rather than take an investment from the French government to preserve French and other European jobs.   As I mentioned in prior blog posts, ALU cannot remain in all aspects of telecom infrastructure, but should follow the path of NSN and focus where the company has scale and competitive advantage. Namely, I think ALU should focus on Access, IP Routing and Optical.

Disclosure: I currently own shares of Alcatel-Lucent, Ericsson and HP although I may look to sell my ALU position in the very near term given points I mentioned in this blog.  NT Advisors LLC may currently or in the future solicit any company mentioned in this blog post for consulting services.

Telecom Equipment Dynamics Remain Favorable

As I have posted in prior blog posts over the past few months, I have been generally positive on Alcatel-Lucent and Ericsson given my view these two stocks were under valued and that a cyclical bullish trade in these two stocks was likely given a better telecom capital spending environment would materialize in 2013.  This past week, three data points came to surface that continue to make me comfortable with this thesis.

  1. Telecom Italia announced it was cutting its dividend by about half, to help fund its capital spending plan for 2013-2015 to support needed network investments in both LTE and fiber based broadband networks.  Capex in each year in the 2013-2015 period would likely remain consistent with the 2012 capex level of about 3 billion.  While cutting the dividend to help fund capex is not ideal, the fact that a large European telecom operator is committing to a reasonably healthy capital spending outlook for the next three years is encouraging, especially for a Southern European telecom operator given the weak economic condition in that region.
  2. Telecom operator KPN of the Netherlands reported 2012 capex of 2.2 billion, at the high end of its guidance of 2.0-2.2 billion.  KPN is another European telecom operator that had cut its dividend in 2012, yet actually spent at the high end of its capital spending guidance.  More importantly, KPN announced that for 2013-2015 annual capex would be in the range of about 2.2-2.3 billion, suggesting capex in each of the next three years would be at the 2012 level or slightly higher. Once again, the drivers for capital spending would be the build out of its 4G wireless network and a more robust broadband wireline network.
  3. Sprint reported 4Q 2012 results Wall Street analysts significantly raised their 2013 and 2014 capex estimates from about $5.5-$6.5 billion per year to about $7.5-$8 billion per year.    This level of capex compares to $5.4 billion in 2012.  Clearly Sprint is planning to be aggressive with its capital spending given the planned investment by Softbank and Softbank’s desire to be major force in the US wireless market.

Europe Has Been Underinvesting; New Competitive Dynamics in the US

What I infer from these data points as well as the analysis of historical capital spending trends is that most telecom operators in Europe have been under-spending given the weak macro-economic conditions in the region as well as pressure to preserve current dividend payouts.  It seems to me that the mindset of European telecom operators might be changing from “preservation” to “growth” which in some cases is supporting dividend cuts in favor of capital spending in growth initiatives like 4G and wireline broadband initiatives.  In addition, the US market could be poised for a new competitive dynamic where the virtual duopoly of AT&T and Verizon will be challenged by a newly funded and aggressive Sprint and the re-emergence of T-Mobile as another wireless operator that invests for growth.  T-Mobile may not have long term aspirations like Sprint in the US and eventually may seek to sell itself to Sprint or another entity. But in the interim period of the next two years, T-Mobile will likely be more of in the investment mode in its network rather than a harvest/sell mode.

While I Remain Favorable, Telecom Equipment Stocks are Very Risky

The telecom equipment market is still a very competitive industry with aggressive pricing pressure.  A more favorable capital spending environment is certainly a positive, but does not ensure stocks in the sector will perform well.  While this is still a risk, I continue to think the bullish cyclical trade has not run its course and remain positive on both Alcatel-Lucent and Ericsson.  Alcatel-Lucent has additional risks of turning around negative cash flow performance since the merger of the two former companies and a sub-scale business.  Thus, it is a much riskier investment than Ericsson.

 Plot Thickens at ALU With A New CEO Search and Press Reports on NSN

In the case of Alcatel-Lucent, the company also announced it is looking for a new CEO.  The outcome of this CEO search will certainly be an important factor impacting the stock performance of ALU in the future.  The WSJ sites NCR current Chairman and CEO Bill Nuti as one potential candidate.  Bill has an accomplished career and I think would be a good choice for ALU.  On the other hand, the job of turning around ALU will be challenging for any new CEO as the company has a high cost structure, especially in Europe, and needs to focus its R&D in fewer areas of the telecom equipment market.  The high cost structure in Europe is a major over-hang, as typical severance packages in France and other parts of Europe require up to three years of salary when employees are downsized.   Large severance payments in Europe will make it difficult for ALU to successfully complete its restructuring in my view.  Thus, any new CEO, regardless of talent and vision, will have to somehow overcome this restructuring over-hang.

Another interesting French corporate development to watch that may or may not have implications for ALU is how the French government deals with similar cost and market demand issues at French auto manufacturer Peugeot.  Press articles discuss that the French government might get involved in the restructuring/turnaround of Peugeot to preserve the company and jobs in France.  Peugeot, however, employs significantly more people in France (about 100,000) than ALU (about 10,000).  In addition, there is precedent in the auto industry for governments to help struggling companies (e.g. the US bailout of General Motors), but we have not seen such support in the telecom equipment market (e.g. the Canadian government did not get involved when Nortel fell to bankruptcy).

Increasing the intrigue on the CEO selection and ongoing restructuring at ALU is another recent press report from Bloomberg indicating that Siemens would like to exit its 50% ownership of the Nokia Siemens Networks (NSN) joint venture with Nokia (Nokia owns the remaining 50% of this joint venture).  NSN has shown three good quarters in a row and is well down the road in its own restructuring plan.  Thus, it is not a surprise that Siemens would want out of the JV as Siemens has been exiting its telecommunications businesses over the past several years and NSN is now more of a stable entity.  Nokia likely wants to stay in the wireless infrastructure business as smartphone competitor Samsung is attempting to win business by bundling smartphones and wireless infrastructure equipment in several of Nokia’s markets.  According to the Bloomberg article, Nokia is considering buying Siemens’ stake directly or in a partnership with ALU.   If in-fact ALU would end up being a part owner of NSN, this would likely be a positive for both ALU and NSN as they would be partners rather than competitors in the wireless infrastructure and services markets.   Given both are distant players behind Huawei and Ericsson in the wireless infrastructure market; a partnership between the two would help both companies. This of course assumes, that ALU is able to fund a purchase of a partial ownership in NSN and the ability for both ALU and NSN to implement further restructuring in their respective wireless equipment and services businesses that would likely result from a partnership between NSN and ALU.  The other interesting angle in a potential partnership between ALU and NSN would be whether NSN would begin favoring ALU for IP routing equipment instead of Juniper Networks, its long time partner for IP routing.  That could be another positive for ALU to come out of such a partnership, besides better competitive dynamics in the wireless infrastructure and services markets.

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

 

 

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.

Return of the Telecom Jedi?

I continue to be positive on large telecom equipment suppliers Ericsson and Alcatel-Lucent.  The main premise behind my positive view is the telecom infrastructure industry is a cyclical industry, and we are likely to see a recovery of capital spending by telecom operators in 2013. This recovery in telecom spending, combined with relatively low valuations for equipment companies like Ericsson and Alcatel-Lucent, should allow these stocks to have good relative performance in 1H 2013.

In addition to this primary thesis on these stocks, I also point to two other recent data points.  First, the strong recent operating results and profits by the telecom equipment infrastructure business at Nokia Siemens Networks (NSN).  As mentioned on a prior blog post, NSN has reported better than expected profit margins in the past three quarters and seems to be executing well on its restructuring plan.  Secondly, I believe the momentum of Chinese based equipment suppliers Huawei and ZTE is diminishing (at least for now), which should bode well for Alcatel-Lucent, Ericsson and others.  This is an important point as Huawei and ZTE have been massive market share gainers and price setters in the telecom infrastructure market over the past decade, which negatively impacted the entire sector.

Both Huawei and ZTE provided financial updates on their 2012 results in the past couple of weeks, which showed slowing momentum in terms of further market share gains and achieving their respective 2012 revenue targets.  According to the Financial Times, Huawei announced in January revenues of about $35 billion for 2012, but that was below the Huawei target of $38.7 billion it was discussing as late as September of 2012.   Over the past couple of years, Huawei has been seeking to achieve its long-term growth targets by entering the new markets of Enterprise Networking and Mobile Devices.  While the company seems to be doing well in Mobile Devices at the low end of the market, Huawei does not seem to be hitting its targets in the Enterprise Networking market.  These new efforts are also spreading the company thin in my view and puts Huawei on a multi-front competitive battle with Cisco and HP in enterprise networking, Samsung in mobile devices in addition to traditional competitors like Alcatel-Lucent, Ericsson and NSN in telecom infrastructure.

As for ZTE, the company pre-announced lower than expected results for 4Q12 last week.  Not only were the results lower than expected, but also some equity research analysts now believe ZTE’s market share gains in the international telecom equipment market have stalled.  Below is an exert from a research report on this topic from UBS Investment Research:

“After large-scale staff layoffs and the closure of a few representative offices in

overseas markets, we believe ZTE’s growth in the overseas equipment segment

will slow significantly. Our channel checks suggest the pipeline for new

contracts is limited. In the longer term, we believe ZTE’s withdrawal from some

developed markets means the prospect of ZTE gaining a top-three role as a

global equipment vendor by overtaking Nokia Siemens Networks (NSN) and

Alcatel-Lucent has become quite slim.”

Source: UBS Investment Research Report Dated 1/28/13

 

Disclosure:  I currently own shares of Alcatel-Lucent, Ericsson, HP and Cisco all of which are mentioned in this report.  I also may solicit any company mentioned in this report as a potential consulting client for NT Advisors LLC.