Weinstein (PaineWebber) very interesting commentary on the networking industry. Many ASND references as a "Gulliver"
Excerpt: "I believe the Gullivers of the networking world will survive the changes in both new and existing
markets. Investors will continue to pay for the might of the giants, despite the attacks from their
smaller challengers."
[Note: "Gullivers" are CSCO, COMS, ASND and BAY]
The Gullivers of the networking world
Marketwise - By Paul Weinstein
NEWS.COM
March 24, 1998, 4 a.m. PT
URL: news.com
These days, network communications stocks just aren't the same old bubbly stocks they used to
be. Once the darlings of Wall Street, their overall performance has been pitiful during the last few
quarters. The DMG Networking composite is down 2 percent compared with a year ago, while
the S&P is up 33 percent and the average Nasdaq stock climbed 35 percent. Such figures are a
far cry from the 40 percent to 60 percent returns of years gone by. A brief rally at the start of the
year merely recouped what was lost in the fourth quarter, and the feeling on Wall Street now is
that these companies cannot regain their past glory.
What's going on?
Well, one thing is that investors now have to adjust to the realities of new competition in some of
the most lucrative market segments--switching, wide-area networking (WAN) backbone, and
broadband WAN access. A second is that the traditional players--Ascend (ASND), Bay
Networks (BAY), Cisco (CSC), Cabletron (CS), and 3Com (COMS)--are moving beyond their
traditional enterprise customers, going after service providers and small business customers.
To get a handle on the first of these issues, I headed off to a network outlook conference hosted
by Technologic Partners, a New York City-based publishing and services firm that tracks strategic
business and financial issues affecting he high-technology industries. At the conference, young,
VC-backed technology neophytes get the opportunity to tell investment bankers, other VCs, and
research analysts why they could be the next Cisco, Ascend, or Microsoft (OK, so I took a few
liberties here).
During the conference, I wondered many times if these neophytes of technology felt like the
Lilliputians that met up with Gulliver. The conference focused on companies that were hoping to
provide communications equipment for the infrastructure of the Internet, as well as the associated
equipment that business customers would need to stay in touch with their suppliers, customers, and
business partners via the Net.
Picking your battles
The current industry structure--increased concentration in older markets and increased
fragmentation in new markets--begs the question: Is it possible that Lilliputians could find the weak
link in the armor of the big guys? Yes, I think it's possible, but it takes a lot of tiny little arrows to
bring down a giant. I would sure be surprised if, a year from now, the landscape was so
considerably different that investors would want to dump their current networking bets. The savvy
upstarts, however, will exploit the weaknesses of their enemies, which usually come in two forms:
Either a new market gets created (ATM, xDSL, cable modems), or someone comes up with a
better way to do something currently being done on a routine basis (Layer 3 switches,
hardware-based routers).
Listening to the various presentations given at the Outlook conference, it was clear that
hardware-based routers--those that use fast, application-specific integrated circuits, or
ASICs--would be a popular arrow in the quiver of the attackers, as would remote access devices
of every kind. Juniper Networks, Avici, Torrent Networking Technologies, and Pluris (collectively
having raised nearly $100 million in venture backing) all were pitching routers that would take on
Cisco's GSR and derivatives, as well as forthcoming Bay and Ascend products.
Given the high likelihood that the Internet will need more not less routing, especially as
faster-access technologies get deployed, I like the Lilliputian's chances. On the enterprise side,
pitching routing function within a Layer 3 box is going to be a tough game. Packet Engines has
staked out the high end, and Berkeley Design Technology is using NT as a differentiator, but,
beyond that, routing seems like a crowded space. Moreover, Cisco, Bay, and 3Com, the current
Gulliver guardians in the space, don't look as if they will be late.
In the remote access space--where Cisco, 3Com, and Ascend dominate the central office and
3Com owns the client side--there was considerable Lilliputian activity. Assured Access had one of
the more compelling PoP, or point of presence, in-a-box solutions, with features that differentiate it
from the incumbents. But the flux in xDSL makes it hard to know who will have the advantage on
the client access side. For now, I would bet on incumbents: 3Com with its control of the retail
channel, and Bay with its leading cable modem market share. Both Com21 and Terayon are
starting to gain ground in cable modems, as the latest cable modem standard, the MCNS, or
multimedia cable network system, levels the playing field. I look for the DSL Lite standard to do
the same for xDSL, creating new Lilliputian opportunities in 1999.
Where incumbency works
Why would I favor Lilliputians in some product categories and not others? Well, I still think the
incumbency factor will weigh heavily in the decision-making process for enterprise customers.
Service providers, on the other hand, are beset by new start-ups, ranging from ISPs to CLECs, or
competitive local exchange carriers, all of which have shown a willingness to bet on the most
innovative equipment providers because time-to-market pressures are much greater in this end of
the business. It used to be that service providers were the slow, plodding monoliths that couldn't
make a decision in anything under a light year, while enterprise customers, with their insatiable
desire for local area network, or LAN, bandwidth, were fast-moving and ready to deploy the next
hot technology. Maturity of the technology and scale of the network has forced IT managers to not
only consider, but in many cases to deploy, the least disruptive, rather than the most innovative
solution. For this reason, the Gullivers of the enterprise space have a strong likelihood of sustaining
their dominance.
I think the opposite is happening in the service provider space. I have yet to find a customer
buying high volumes of Internet infrastructure equipment that won't at least give a new product
from a start-up a shot. Moreover, this segment has inherently fewer customers than the enterprise
space, virtually removing the distribution problem every start up-in the enterprise space faces.
Finally, sales to a service provider tend to be much more of an engineering sale, especially for core
or voice-data integration products, which again favors the new entrant.
Owning stocks is different than conquering a market
Following the conference, I was amazed at the number of CEOs and VCs that couldn't understand
why, with all the emerging opportunities in gigabit routing, Layer 3 switching, CLECs, cable, and
xDSL access, investors would continue to bet on Gulliver. The answer is simple. Portfolio
managers get paid for outperforming the S&P 500, not for being the first to discover a hot market
(though, admittedly, one could lead to the other).
Portfolio managers own the networking companies because they provide a "safe" way to play a
very fluid area of technology. Why safe? First, owning the big stocks is like owning a proxy for the
industry. I estimate the annual revenue potential for the group to be between $35 billion and $55
billion over the next three years, spread across at least ten market segments, with more emerging
every year. Investors are not betting that Cisco or Bay or 3Com will be first to enter a hot new
market, they are betting that they have sufficient resources to enter all markets and not miss a
product cycle! Second, the stocks are liquid, therefore providing an easy means of entry and exit.
Bay, Cisco, Ascend , and 3Com all routinely trade multiple millions of shares per day. Third, all of
these stocks have market values of several billion dollars, which means that these stocks can be
purchased in sufficient size such that their performance can actually impact a portfolio valued at
several billion dollars.
What does all this mean?
I believe the Gullivers of the networking world will survive the changes in both new and existing
markets. Investors will continue to pay for the might of the giants, despite the attacks from their
smaller challengers.
Paul J. Weinstein is a managing director for PaineWebber based in San Francisco, and is a
member of the technology research group within PaineWebber's equity research
department, where he specializes in analyzing the network communications equipment and
data storage industries.
Free memory upgrade guide. Click here.
Back to Perspectives
Copyright c 1995-98 CNET, Inc. All rights
reserved.
|
