There has been some news in software-defined networking (SDN), though there is nothing that will immediately impact the share price of companies. However, there are large implications for software-defined networking from lowering operating expenditures, lowering capital expenditures, and offering features immediately rather than through the next update cycle. Software-defined networking will be lucrative for whomever leads the market. The bulk of the rewards remain a few years out, but the winners will begin differentiating themselves now. A few potential customers are expected to start testing SDN in about a year.
Treatment for the Sick?
Is this an illusion?
Alcatel-Lucent (NYSE: ALU) announced at the beginning of April that it is entering the enterprise SDN field, making it one of the latest networking companies to join the fray. It sounds like a good idea in concept, but it all comes down to implementation. Alcatel-Lucent is entering the field fresh just like the other companies in this space. The company actually created a separate entity named Nuage Networks to create an SDN solution. This allows the creation of a broader solution instead of one just tailored to Alcatel-Lucent’s boxes.
Alcatel-Lucent has lightRadio and its new core router, which are just picking up steam. SDN could be worth billions to Alcatel-Lucent eventually, and I understand the impetus to not get left behind as every single networking company is working on SDN. However, the number one priority for the company needs to be cutting expenses.The company has $20 billion in revenue and not a cent of profit. Creating a separate entity to handle SDN actually seems like a good idea as that company can be funded like a start up. Alcatel-Lucent has cash available to finance some development despite its condition. On the home front, its new CEO can focus on cutting away the fat.
I have call options on the run I expect if the company even turns slightly profitable on cost-cutting. However, my outlook is five years. By that time SDN will probably be a major force in networking, so it behooves companies to get in now. Despite all its problems, Alcatel-Lucent is not falling behind, which would be a true death knell for the company. Alcatel-Lucent investors can breathe a very small sign of relief.
The Networking Giant’s Hand
Alcatel-Lucent is going up against Cisco (NASDAQ: CSCO), which is hosting an SDN consortium. It is supporting an open-source SDN. Not sure of the significance just yet, but Cisco has a lot of capital to put into SDN if it sees major potential.
Cisco seems to be taking a two pronged approach to SDN. Being a hardware company, it is fully backing the version of SDN that would keep customers wanting their boxes. They are doing this through specialized hardware that other SDN providers are trying to virtualize. The risk for Cisco is that the pure software approach becomes the most popular. Software’s success would reduce Cisco’s revenue from hardware, and Cisco would need to make this up and more in order to continue growing. It would be easier to grow revenue if your primary business was not shrinking. For now, there is no sign of Cisco hitting flat or declining revenues.
The last few years have been good to it. Some people wish growth were faster, but that seems unreasonable given the economic environment. I do not think Cisco’s share price can stay down for long. It seems to be subject to the whims of the overall market and not trading on its merits. Even if revenue is slower than people want, net income has been increasing at a very fast rate. While still slow, 2013 is expected to be better than 2012, but 2014 and beyond should see a lot of the pent up demand released as companies are forced to make purchases. Hopefully, Cisco can be there to provide them with what they need. With its $45 billion in cash I think it will be.
There is no Spoon
VMWare (NYSE: VMW) is the bastion of virtualization, and is becoming a huge name in the cloud and the intersection of those two ideas. VMWare started the SDN frenzy with its purchase of Nicira. The question is whether its SDN strategy will be the portion of a bigger SDN framework that only deals with managing its virtualization platforms and their network connections, or will it go full bore and completely virtualize the network.
It does not make any sense for VMWare to play nice with network vendors if it can offer its own solution in the long-term. If it can fully virtualize the network, then I think it will. VMWare is the one company that is not seeing a threat to its core business. SDN would be purely additive to its growth story versus Cisco and Alcatel-Lucent where there might be some subtraction on the hardware side.
VMWare is now in the $70s, well off its highs from the heady days of $105. It is a profitable company, but the share prices suffered due to it guiding below analyst expectations. After a slow 2013, VMWare is expecting 2014-2016 to be fantastic driven by revenue growth and higher margins. Whatever it has done thus far to change how companies do business with virtualized machines or how users use the cloud will not be the end of it. Considering the huge decline in share price caused by a weaker than expected 2013 outlook the market is underestimating the long-term potential of the business on short-term weakness.
Since SDN is a few years out, I am willing to venture that it is not yet incorporated into expectations. As I mentioned early adopters might start testing in one year, and so 2-3 years might see SDN rolling out to customers. The company already expects fantastic growth, I think SDN will boost that growth significantly.
Conclusion
There are some targets that have VMWare going lower. I like the multi-year outlook, if you are worried about getting them cheaper sell puts at the acceptable level, and keep rolling until you either get your shares or feel comfortable taking a straight long position. I like Cisco a lot and am hoping that my 2014 calls pay off. It has enough cash to accomplish something great. I am un-popularly bullish on Alcatel-Lucent’s turnaround and have taken some steps to profit from it. I like it because no one else does, and my LEAPs will pay off huge if I am right, and my risk of loss is relatively small.
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