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Market analysis

The networking equipment industry is under pressure. Revenues for the companies in our sample for the sector declined by 10% year on year, but realized a 6% increase sequentially.  The sequential increase was led by Ericsson and Motorola Solutions revenue growth of 20.4% and 22.9%, respectively. Year over year net income also dropped sharply by 35%. Three out of the four companies under study in the sector reported declines in net income year on year, with LM Ericsson leading the way with a 121% decline.

The 4G market has slowed, and 5G technology has not yet fully been rolled-out. As a result, the industry is expected to remain under pressure in the near future. For now, it is all about saving costs in order to maintain margins.  Nokia has been able to achieve some cost efficiencies and synergies from its Alcatel-Lucent acquisition, but overall margins still declined.  However, the acquisition has started to positively impact revenue.  Growth in Alcatel-Lucent's Submarine Networks resulted in full-year segment revenue growth of 34%.1

A comparison with other industry players shows that almost all companies in the sector are having a tough time dealing with declining sales growth. Nokia's gross margin has come down to around 36% in the last year, down from around 44% in 2015. Falling sales and a stronger dollar have resulted in lower gross margins for the company. In comparison, Ericsson has lost substantial sales, and its gross margin is at 28%. Ericsson had the lowest gross margin of the four companies compared here.1

Internet of Things infrastructure spending is making inroads into enterprise IT budgets across a diverse set of industry verticals. Given the strong uptake in IoT-based technology solutions, enterprise IT buyers are looking for vendors who can add IoT capabilities to the current networking and edge IT infrastructure. Further, success of IoT initiatives will also depend on how IT buyers can effectively leverage newer frameworks of low-power connectivity mechanisms, network virtualization, data analytics at the edge and cloud-based platforms. This is adding new challenges to networking/communications companies. There is increased demand for newer networking elements that can address the needs of IoT traffic behavior. WiFi and Bluetooth low energy (BLE) are top contenders as preferred IoT connectivity mechanisms.2

Long-range, wide-area networks (LoRaWAN) and narrowband IoT (NB-IoT) are equally poised to provide tough competition to WiFi and BLE vendors. Data analytics, correlation and pattern recognition capabilities at point-of-data creation are proving to be key decision factors in vendor evaluation. There will be a significant shift towards edge server deployments as well as broader adoption of public cloud-based services for IoT.2

Before the benefits of 5G—the latest technology in networking—can be realized, the technology must overcome some obstacles. As devices evolve into a more complex state, wireless standards must follow. The evolution from 4G to 5G has huge potential to substantially change the value offering, but 5G comes with potential barriers, including the adoption of formal specifications, the roll-out across carriers and the management of signal attenuation. The FCC has approved spectrum in the microwave bands of 28 GHz, 37 GHz and 39 GHz. These higher frequency bands are needed to achieve the allowable channel bandwidth required to reach the data rates, which will be 1000x higher than those of today’s 4G LTE speeds. Telecommunications companies such as T-Mobile and Ericsson have demonstrated trials with download speeds of more than 12Gbps and latency—the time it takes for data to travel between source and destination—at under 2 milliseconds. Next, the carriers need to incorporate all of this into their own build-outs. Not only will 5G be adopted as the standard in fixed wireless devices, but there are also many potential applications for 5G for the connected home and smart city that will improve communication bandwidth and speed: TVs, traffic lights, IoT devices, VR applications and games and self-driving cars.3

Reflecting the tough environment, Cisco reported second quarter revenue of US$11.6 billion and net income ofUS$2.3 billion. Total revenue was down 2%, with product revenue down 4% and service revenue up 5%. Revenue for Americas was down 3%, EMEA was flat and APJC was down 3%. Total gross margin and product gross margin were 62.8% and 61.1%, respectively. The decrease in product gross margin compared with 61.3% a year ago was primarily due to pricing and, to a lesser extent, product mix, partially offset by continued productivity improvements and the divestiture of the SP Video CPE Business. As of January 28, 2017, Cisco had repurchased and retired 4.7 billion shares with an aggregate purchase price of approximately US$98.6 billion.

Cisco is launching four next-generation firewall boxes aimed at giving smaller organizations protection that is better sized to their needs and engineered to reduce performance issues as additional security services are turned on. The devices are built around dual, multi-core processors. That architecture enables custom processing of traffic requiring threat inspection, and also supports tagging traffic that doesn’t need threat inspection so it flows through only the separate network processing unit.4

In an effort to enhance its software business, Nokia is looking to acquire Comptel for around US$370 million. This deal demonstrates Nokia’s intent to move beyond royalty payments collection from its patents business. The Software solutions business has the potential to grow considerably and help Nokia to diversify beyond its core telecom hardware business. Comptel provides services to operators in 90 countries. It will bring a large customer base to Nokia. Additionally, the combination of Nokia and Comptel technology will give the company a better chance to further grow the business and increase penetration.5

 

1.Seekingalpha.com, Feb 2016

2. Gartner, Jan 2016

3. Networkcomputing.com, Jan 2017

4. Networkworld.com, Feb, 2017

5. Venturebeat.com, Feb 2017