Third Great Router War Leads Industry Transition
Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Calling what is occurring a transition is probably a bit bold, because it really is just about more. More power, more capacity, more data. There is no inherent change in the way routers function. The Internet is just invading more and more aspects of our lives. Everything you own can link up to the Internet not just your phones. The move to the cloud means that massive amounts of data are flowing on the Internet's rails instead of local networks with expensive systems replicated at all the possible locations they would be needed. Now you have one central location for data and services and only need interface systems.
Alcatel-Lucent Jumps Into The Core
You can think of the Internet as a nexus of access routes, interchanges, and hosts. The hosts are the servers and hosts. Your computer would be a host. The access routes include all the cables and interchanges are routers. The amount of data on these routes is increasing dramatically as the Internet invades all things we do. To handle all this traffic, bigger and better networking technology will be needed. I am using my own terminology to explain my understanding. It might overlap with official terminology, but I mean the terms as their standard definitions would suggest.
Enter the new Alcatel-Lucent (NYSE: ALU) core router. It is built on a lot of the innovations that helped make its edge router number 2 in the market. Being number 2 is less impressive when you consider that it's only a 24% market share, but ALU needs all it can get. It also went into the market with nothing and built itself up. The edge router is a fantastic piece of technology and the routing chip they have in the most recent models, the FP3, is amazing.
The new core router is a beast of a machine with 160 ports running at 100GB full duplex. Full duplex means down and up speed can be at 100GB/s at the same time. There are more technical details I will spare you from, but those technical details are interesting to me. After all it is the company's product, which is the key toward revenue.
The top-line version is two standard boxes linked to behave like one system. There is also a small standalone model for customers who do not need crazy levels of capacity. Now normally clustering reduces the utility per unit due to inefficiencies. For large clusters the idea is to get the inefficiencies as low as possible. With just two standard units interlinked the point is to function as only one system. All the marketing materials and datasheets point to it as one big uber-system instead of linked systems. These boxes will also be stacked into larger networks called multi-chassis support. The system also uses less energy while providing a lot more power.
Verizon already uses ALU's edge routers and hopefully they will at least give the core routers a trial. Telefonica is already in trials with the router. The product is new so there have not been any confirmed high-value deals. The trials are good signs, but not guaranteed.
The core router market is $4.5 billion, per year if I can trust what I have been reading. That is pretty big money. Also, I would not be surprised if it grows faster than that. Standard Internet with computers is one thing, but now all our mobile services are moving to the traditional Internet. The difference between "phone" services and Internet services is disappearing, though the distinction was probably a fiction the entire time anyway.
The Incumbent Champions
Cisco (NASDAQ: CSCO) is ever present in the core routing space. Cisco was the winner in the first router war when it became a market leader. The war was not as heated since the Internet was new. The company is huge with a strong balance sheet that has a ton of cash at $45 billion. That buys a lot of marketing and sales. Cisco is a gigantic company and it has other sources of revenue. The core routing segment is a portion of it. The company has $50 billion in revenue if I were to round up. It is not sounding the emergency siren if it sees lower market share. As far as I can tell the core routers ALU is selling can beat Cisco's on a 1-to-1 basis. However, ALU's product is not yet ready for multi-chassis. ALU's product is designed to give everything in one package with multi-chassis as the next step. The current core routers rely on multi-chassis as the first step.
Juniper Networks (NYSE: JNPR) managed to carve a place for itself in the second router wars. Everything I read calls the situation in the core router space a duopoly between Cisco and Juniper. Juniper is the minority in that relationship. Juniper's revenue is only $4 billion. Core routing is its bread and butter. It was a bummer for the company when ALU jumped into the edge router market. The fact that the company created a nice market share for itself means that its foray into the core space is at least a concern if not a serious threat. Juniper losing market share in its main segment would create problems. Juniper's margins have been low around 8%, when a few years ago they were pushing 15%. Making less sales would further depress net margins or flip them negative. Cisco has margins above 20%.
ALU has been losing money, but the bar of success for a company like that is much lower. Juniper is not the most beaten up company on the market. It is not an unassailable cash machine that is a straight buy and forget. It is in the murky middle. ALU has far more potential that can be had for far less cost. Cisco is the nice diversified juggernaut with a nice, but not hefty, dividend.
Announcing the Third Router Wars
I am being way too dramatic, but it is way more interesting than being boring. Cisco is likely to be the titan on the passive defense. Juniper will be proactive about maintaining relationships and winning clients. ALU is the upstart hoping to make a name for itself. Craft your own investment ideas. I like Alcatel-Lucent's balance of risk to reward, and Cisco's long-term outlook. I still need to take my ALU position, but I will soon enough.
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