Alcatel-Lucent’s SDN Strategy: A Positive Catalyst?

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Deutsche Bank’s Kai Korschelt recently raised his rating on the shares of Alcatel-Lucent (NYSE: ALU) to Buy from Hold, and set a price target of €1.80 on the ordinary shares traded in Paris, after concluding that the company “has the key ingredients for a potentially successful turnaround: A new CEO with a solid cost-cutting track record, a likely positive revenue and margin inflection in 2013/14, and a termed out maturity profile.”

Korschelt believes Alcatel has set some ambitious targets for 2015, such as revenue of €15 billion and gross margin of 35% to 37%. He says:

If we assume ALU execute on their targeted Opex savings but only achieve half of the targeted Gross Margin improvement by 2015 (+300bps vs +600bps target), the stock currently trades on only 5 to 6x 2015 P/E. If Gross/Operating Margin targets are reached, ALU’s 2015 P/E could be as low as 2 to 3x.

Alcatel-Lucent is one of the largest telecom equipment providers in the world with annual sales of ~$20 billion. Recently, Alcatel-Lucent has decided to enter the SDN (software-defined networking) segment after realizing the potential of this market. 

Alcatel-Lucent’s SDN Initiative: Visualized Services Platform (VSP)

The networking industry is taking a new shape, and most of the companies operating in the industry are trying to reengineer themselves. Software-defined networking or SDN is the future, and this will provide the future growth for networking companies.

Nuage Networks, an Alcatel-Lucent internal startup focused on SDN solutions, has just introduced Visualized Services Platform (VSP), an open software-based solution, to address the key data center network constraints that limit cloud services adoption.

The platform is targeted at the large enterprises and carriers. The system mixes the IT and networking knowledge of the company. VSP is based on Alcatel-Lucent’s service router operating system, and it uses distributed routing and switching to virtualize layers.

VSP will allow healthcare, banking, utilities and other enterprise market segments, as well as large Internet-based companies and telecom service providers, to scale their cloud offers and provide instant, secure connectivity to multiple customers. Michel Combes, new CEO of Alcatel-Lucent said:

It’s exciting to start my first day as CEO of Alcatel-Lucent with an announcement that expands our addressable market. Alcatel-Lucent’s SDN strategy and the Nuage Networks branded portfolio announced today builds on the cloud orchestration we already provide with our CloudBand™ Management System. We are very well positioned to help telecom and cloud service providers build large scale cloud infrastructure and services, opening up new revenue opportunities for our customers and ourselves.

The Challenge

Nuage's VSP is positioned as the first of the second generation virtualized services platform. The challenge for Nuage is dominant players like VMware (NYSE: VMW), which bought Nicira and Juniper (NYSE: JNPR), which bought Contrail.

For VMware, Nicira is part of an effort to put together what it calls the software defined data center. VMware has obviously established a dominant presence in virtualizing servers in the data center. With Nicira, which only just started production systems, VMware acquires the networking part of the virtualization stack. VMware is also owned by EMC, which happens to focus heavily on virtualizing storage.

Nicira has a strong customer roster including AT&T, eBay and Fidelity. Nicira's flagship product is the Nicira Network Virtualization Platform, which aims to speed up services. VMware said it will continue to support Nicira's Open VSwitch technologies. 

Juniper acquired software-based networking startup Contrail Systems for $176 million in cash in December 2012. Contrail was only founded in 2012. It is probably worth noting that Contrail's chief technology officer, multi-protocol label switching (MPLS) specialist Kireeti Kompella, was at Juniper before defecting in September.

"With this acquisition, Juniper gains SDN technology that augments our portfolio of products and services," Juniper software Chief Bob Muglia said in a post. "As a strategic investor earlier this year, we recognized the inherent advantages of Contrail Systems' architectural approach and we are excited to take this next step to acquire and combine Contrail Systems into our team."

Conclusion

I like Alcatel-Lucent mainly because of its potential for making a turnaround. The company has one of the strongest R&D portfolios in the telecom industry and manages to sell $20 billion in telecom equipment each year. The company’s recent foray into SDN will undoubtedly act as a strong positive catalyst for the stock.


Anindya Batabyal has no position in any stocks mentioned. The Motley Fool recommends VMware. The Motley Fool owns shares of VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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