"The conventional wisdom of a year ago is probably correct," said Paul Sagawa, an analyst at Sanford C. Bernstein & Co. "I don't see any way these guys can stop Cisco from taking what's theirs."
The Wall Street Journal -- September 30, 1999
Technology Journal:
Internet IPOs Challenge Conventional Wisdom
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By Scott Thurm
Staff Reporter of The Wall Street Journal
The sizzling debut of Foundry Networks Inc. on Tuesday is yet another reminder of the perils of conventional wisdom.
A year ago, the market for faster, smarter switches to route traffic across the Internet was considered hopelessly overcrowded and not particularly promising. An initial crop of two dozen start-ups had dwindled by half, and most of the survivors were scrambling to find partners, leaving a few wallflowers to join the dance.
A year later, the wallflowers have blossomed into the belles of the ball. Foundry, Extreme Networks Inc. and Alteon Web Systems Inc. are worth a collective $13 billion after successful public offerings.
Most of that is tied up in Foundry, of Sunnyvale, Calif., which has a market value of $7.2 billion -- despite a 17% decline yesterday, its second day of trading. Alteon, San Jose, Calif., is valued at almost $3 billion, despite lifetime revenues of $40 million and accumulated losses of $30 million.
What confounded the conventional wisdom? First, it swept too broadly, lumping together companies that targeted different markets. Second, it underestimated the growth of the market, and may have overestimated potential competitors. More than anything else, it failed to anticipate how Wall Street's infatuation with the Internet would come to focus on those who make network plumbing, as well as those who sell electronically.
"These markets have turned out to be huge . . .," says Geoff Yang, a venture capitalist at Institutional Venture Partners in Menlo Park, Calif., which invested in two switch start-ups, including Foundry. He adds, "Some of it was planned and a good chunk of it is luck." Which suggests that last year's conventional wisdom may prove to be not so wrong after all.
But first, a little background. Foundry, Extreme, Alteon and the others were formed to make corporate computer networks faster. Most office networks now transmit data over Ethernet cables at 10 million to 100 million bits per second. These companies set out to make gear that would work at one billion bits, or a gigabit, per second. They were dubbed the "gigabit Ethernet" crowd, and by 1996 were so numerous that one start-up named itself Yago Systems Inc., short for "Yet Another Gigabit Operation."
The crowded field, and looming competition from established players such as Cisco Systems Inc. and 3Com Corp., made a shakeout inevitable. By 1997, the start-ups began to seek partners that would help them complete and sell their wares. Yago, for example, was acquired by Cabletron Systems Inc., Rochester, N.H., for about $200 million in January 1998.
Meanwhile, some of the original entrants began to mutate, seizing opportunities created by the explosive growth of the Internet. In addition to directing traffic around office networks, for example, the switches also could direct traffic among different computer servers at busy Web sites. Alteon, the first to highlight this capability, even changed its name, morphing from Alteon Networks into Alteon Web Systems earlier this year.
Now, server-switching is considered a lucrative additional market for these companies. Market researchers at Dell'Oro Group in Portola Valley, Calif., estimate that the market for advanced Internet switches will grow from $2 billion this year to almost $5 billion by 2003. Others think those figures conservative, as more software programs are shifted to the Web and remote server "farms." Foundry, for example, gets roughly half its revenue from Internet service providers such as America Online Inc. and operators of server farms.
Finally, Cisco, the industry colossus, took longer to produce gigabit Ethernet switches than most analysts predicted, breaking into the market late last year. That gave Extreme and Foundry an opening to sell to companies that wanted to upgrade their networks.
Still, many analysts think Foundry, Extreme and Alteon are merely the latest beneficiaries -- and likely future victims -- of a mania for Internet-related stocks. The bottom line, these analysts say, is that both pillars of the old conventional wisdom are intact: The market for advanced Internet switches remains very competitive, and Cisco is still a formidable rival.
Nine switch-makers recorded sales of at least $10 million in the second quarter, according to the Dell'Oro Group. Cisco, despite its late entry, has leaped to the head of the pack with roughly a 30% market share. Nortel Networks Inc., another big player, is second, with roughly a 20% share, the Dell'Oro Group says. And chipmaker Intel Corp. recently said it, too, would begin making gigabit Ethernet switches as part of a broad push into networking.
"The conventional wisdom of a year ago is probably correct," said Paul Sagawa, an analyst at Sanford C. Bernstein & Co. "I don't see any way these guys can stop Cisco from taking what's theirs."
The skeptics say it will be harder for the start-ups to stay ahead as prices fall and the chips for advanced switches become more standardized. They could take heart yesterday, when shares of both Foundry and Alteon sank. Foundry fell $26.25 to $130 and Alteon dropped $16.125 to $77.125. Extreme, which is valued less richly than the others, rose 31.25 cents to $66.9375.
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