Why the Disconnect? Public vs. Private investors on IoT

I  have been doing a lot of work around IoT (the Internet of Things) lately. It is a subject of near universal interest among the kinds of people I hang out with. Hardware, software and component makers are all trying to find some way to tap into the market. Bankers and investors are constantly looking for IoT ideas. Whenever I meet a company that has sensors or a field crew or sells $0.10 components into cars or machines, I suggest they rebrand themselves as an IoT company if they want to give their valuation a boost.

All joking aside, the reality is that almost no one has an actual ‘IoT business’ yet. There are barely a handful of public companies that can credibly make this claim, and their valuations are priced for that scarcity. Most public investors know this, and tend to be very skeptical about anyone making IoT claims. This reality was the idea that sparked my big report two months ago laying out what the IoT hardware landscape would look like. I am not saying that all IoT businesses are hot air, there are some real businesses emerging, especially in the software domain. However, the industry is in very early stages relative to where some people think it can go. I saw a book today called “The Zero Marginal Cost Society”, with the alluring sub-title “The Internet of Things, the Collaborative Economy and the Eclipse of Capitalism”. That last bit about capitalism stuck with me long enough to inspire this post. I think it is premature to say IoT can spark that sort of change. Maybe, someday. But we have several more cycles to go through before that can even be attempted.

As I said, I think most public investors are aware of the hype cycle surrounding IoT. However, there is one category of investors who view things very differently – private equity. I have heard this from many different bankers. Last year, there were several ‘IoT companies’ on the auction block, and they were sold for healthy multiples. Multiple sources have told me that those auctions attracted a huge amount of interest from ‘financial buyers’, as opposed to ‘strategic buyers’ or actual companies. There is a sense that IoT is going to spark a drastic change in the operations of non-tech companies, and private equity buyers want to participate in that. If you start with the premise that IoT is coming in a big way in the next five years, then I suppose there is appeal in owning a company that will enable that wave. These companies also tend to be relatively low-tech – in the sense that they are focused on the problem of retrofitting industrial infrastructure like delivery trucks and factory machinery. This area has a lot less technology risk.  As I noted in my report in June, all the technical building blocks for IoT are largely mature – Wi-Fi and micro-controllers are well-established technologies. These kinds of companies have cash flow from service contracts and the like, which appeals to private equity buyers. By contrast, venture investors who want to take on technology risk seem to be much more focussed on the software side of IoT

What really stands out to me is the depth of private equity interest in IoT, with some of last year’s auction attracting twenty bidders, and people calling in favors just be on the shortlist. Public market investors now tend to be very choosy about assigning IoT valuations to companies. By contrast, the businesses that are attracting private equity buyers attract a lot of bidders, even when these businesses have been around for years doing things far more mundane than eclipsing capitalism.

I am not going to say there is some kind of IoT Bubble. There are definitely reasons for private equity buyers to want to participate in this field. Nonetheless, I can not wholly reconcile the different levels of interest between the public and private markets. One interpretation could be that private equity buyers have a longer time horizon than the average hedge fund manager. I am not so sure about that. Another could be that there are many companies today which need to re-tool for future IoT businesses, and the best way to do that is with private equity capital. This thesis seems to be supported by the news yesterday morning that Motorola Solutions sold a stake in itself to the arch-Tech Private Equity firm Silver Lake specifically to ‘transform’ its business. On the other hand, it could just as easily be argued that this has nothing to do with IoT, and is all about smart financial engineering, a thesis borne out by the fact that Motorola will use some of the Silver Lake funds to increase share buy backs and the like.

When it comes right down to it, maybe the answer to all this depends on what we expect from the Internet of Things. The name alone conveys some lofty hopes. For people looking to transform or disrupt the whole economy, IoT carries much promise but is also a distant goal. By contrast, for those looking to help old-style industry re-tool for a digitally-enabled world, there are some nice cash flow streams out there which can support some big investments for growth in a few years. If the goal is to enable some Big New Idea, it is hard to find good investment opportunities. On the other hand, if the goal is to supply investment capital for a business that attaches wireless modules to cement mixers, maybe there are some good deals out there.

A Practical Guide to IPOs Chapter 8 – The Expectations Game

KEY LESSON: Under-promise, over-deliver. And be smart about the model you give out

Every 90 days public companies report quarterly earnings. For most companies, this will be the biggest news for the quarter and likely the biggest trading volume day for its stock. This generates a lot of anxiety and a lot of misunderstanding, but in reality the process is very simple.

Although companies publish complete results, 90% of investors will only look at four data points: 1) current quarter revenue; 2) current quarter earnings per share (EPS); guidance for 3) next quarter’s revenue; and 4) next quarter’s EPS.

Investors will compare those four data points to ‘expectations’ and make big decisions based largely on those numbers. These ‘expectations’ are usually the consensus estimates published by First Call and other market data services. In turn, those consensus figures are compiled by surveying the sell-side analysts who cover the stock.

Management teams have to put in a lot of work preparing for each quarter – closing the books, settling up with auditors, writing an earnings script, and preparing for investor Q&A sessions. But the sad truth is that most investors only process those four data points. Even those who take in the rest of the data view everything else through the prism of those numbers.

The goal for management teams is straightforward – beat expectations. Companies that beat expectations on all four metrics tend to see their stocks go up. Stocks that miss all four metrics tend to see their stocks go down. With all the expected variations in between. In some cases, a few other metrics matter, Twitter investors for example have been watching usage figures a lot lately. But in all cases, these metrics are compared to some set of expectations held by investors.

All of this is incredibly important to newly public companies. When I was an analyst I used to advise companies that there are only two things companies have to do after going public – beat all expectations on their first earnings report as a public company, and beat all expectations on their second earnings as a public company. Beyond that, we can work things out, but miss either of those two and you can go straight to the last chapter of this book “5 Years in the Wilderness”.

As with most things in Life, these first two quarters matter because first impressions matter. Most management teams are completely unknown to public market investors. Maybe the investors met management on the roadshow, or maybe they just saw video presentation online. These earnings calls are a public stage on which management teams reach a wide audience. That audience of investors use this demonstration to measure management’s credibility.

Teams that forecast 90 days out and hit those numbers are seen to have a good understanding and a stable business. Teams that miss those quarters… well that just raises a lot of questions. Is the business bad? Inherently unstable? Not as good as promised? Does management understand their business? Who is driving the ship? For more seasoned companies, investors will already have opinions about the answers to those questions and a track record by which to judge. For newly public companies, investors assume the worst and move on to other stocks.

So meeting expectations is really important. The thing to remember in all this, the silver lining, is that newly public companies are the ones setting the expectations which they themselves then have to beat. At no other point in the company’s life will they have such a free hand in setting those expectations. Once they are public, any analyst covered by First Call will have a vote in setting consensus expectations. But prior to the IPO, management is the sole source of all information. During the Org meetings with analysts and on the roadshow, management gives out its financial model. These eventually become analyst models which then end up as consensus. (Note: There are some wrinkles around the timing of the IPO and the analysts’ first publication of estimates, but in the beginning consensus usually looks a loot like what management says about their model.)

Management teams need to remember any investor or analysts building a financial model is going to take every number given to them and then extrapolate it. If a company goes public in January and estimates 100 subscribers by year-end, then everyone is going to model they have 25 in the first quarter, and be disappointed when the number only comes in 18. So management teams need to think through what numbers they give out, and how to communicate them.

Wait. Didn’t I just say that only revenue and earnings matter? Yes, for most companies, but the beauty of the IPO process is that companies can choose where they want investors to focus. This is especially true for companies that are not yet profitable. Maybe the number is users, or subscribers or some very weird, non-standard profitability metric. Whatever. Choose a number that: 1) you think you can forecast consistently; and 2) bears some resemblance to your actual business. Companies on an IPO roadshow can craft their own expectations. But this opportunity does not last past the first day of trading.

By this point in this series, we are 8 chapters and about 10,000 words in. The most important message to take away from all of that is:

When you provide financial forecasts for your IPO, make sure that they are numbers you can beat.
As always, do not break the law. Do not violate accounting standards. Do not do anything that hurts your real business. Just be smart about the model.

This is Chapter 8 in “A Practical Guide to IPOs”. The series begins here, and Chapter 7 here.

Chapter 7 – The Dividing Line or How to Prepare for Public Markets

KEY LESSON: Be reasonable about what your company can accomplish

In the last chapter, we took a speedy tour through the IPO process. I now want to return to that key pint in time when management teams first start to introduce themselves to the public side of the IPO process.

Some time after picking underwriters, the banks start to introduce their analysts and salespeople to the company. This serves two purposes. One, it helps the banks’ various teams get to know the company. Two, it serves as ‘rehearsal’ for management’s presentations to public investors. There are also legal obligations involved for the underwriters who have to perform some degree of due diligence on the company’s that they are bringing to market.

From a purely functional standpoint, this stage in the process involves a second ‘org’ meeting in which the management team presents to all of the underwriters’ research analysts. Crucially, this includes a financial projection. The analysts then take these materials and start building their financial models and eventually publish research notes. The published pieces are an important way to get companies’ messages across to investors. More importantly, those financial models will then be used to set ‘consensus’ earnings estimates. THIS IS A BIG DEAL. After the IPO, when companies report their first quarterly earnings reports (never more than 90 days from the IPO), management will be judged by the comparison of the actual results to those consensus expectations.

In practical terms, things can change between the Org meeting and the IPO. There is room for a change to those numbers. But analysts will already be making judgments about management as that happens. I worked on an IPO once where the company repeatedly delayed its IPO over nine months. In that period, they updated their forecasts to us four times. If the company had gone public at the start of that period, they would have missed three quarters in a row. Public market investors would have stopped paying attention after the second miss. We made that clear to management, and I can only imagine it was a factor in their decision to sell the company at a discount to what the bankers had long before pegged as their IPO valuation.

Let me just repeat all this, because it is probably the most important procedural point in the IPO. The clock starts ticking the moment when management first gives numbers to anyone on the public side of an IPO. Judgments are being made. Think very carefully about what numbers you give out. And then think about what a reasonable person would guess is the number after the one you give out.

I have focussed on the numbers here because they become mental anchors for everyone involved, but the rest of the presentation carries a lot of weight as well. Management teams need to put real effort into preparation. They should not expect to get the whole pitch just right on that first presentation. Instead, use the analysts to improve the slides and adapt it to what works with investors. Research analysts and equity sales people make a living arguing with fund managers, so they know a thing or two about what works and what does not.. (And if you want to be extra cynical, asking a research analysts his opinion and taking notes on the answer is a great way to ingratiate yourself with that analyst. “Thanks, that’s a great insight!”)

At this stage, management teams likely know their bankers very well. So a common mistake is to let the bankers determine the presentation of materials to the research analysts. This does not work because bankers almost never talk to fund managers. They may know them socially, and share timeshare private jets with fund managers, but they do not make a living arguing with fund managers. Bankers have a tendency to paint things as overly-rosy. Fund managers will look for reality and grit and real-world trade-offs. The goal of  this ‘org’ meeting is to prepare a very tight presentation for the roadshow, and the roadshow is an exercise in debate, not an exercise in propaganda.

In the next chapter I will tie all this up and examine what management teams should actually present on the roadshow.

Q apitulation

Qualcomm had some big news after the close, announcing that they were enacting a massive corporate restructuring. This included a huge reduction in workforce and other cost-cutting measures, as well as promises to buy back more shares and increase their dividend, and even potentially to split the company in two. They are rotating out three board members and only adding one back, thus shrinking the board. Big changes.  
This is all in response to Jana Partner’s activist campaign against the company launched back in May. Jana actually got to pick the two incoming board members.

This is capitulation with a Capital Q.

And as far as we the public know, Jana did all that with a letter. 

I first wrote about this when Jana launched their campaign, and in that post I said the best way to defend against an activist is to give them most of their demands without actually ceding too much power. Giving away a fifth of your board seats definitely fails that test.

The company also announced some pretty messy results as well. During the conference call, management spent most of their prepared remarks talking about the restructuring rather than the results. They mentioned cost reductions about 137 times by my count in their comments. Going back to my earlier post, they certainly have a lot of things they need to cut. When companies get as big as Qualcomm is, there are always lots of inefficiencies.

So a generous interpretation of today’s news is that the management team realized now would be a good time to  change the culture and fix the cost structure. They have tried before, but now they can use the outside influence as an extra tool to leverage change.

That is the generous interpretation, because it is hard to think of another reason why the company would give in so much, so quickly.

As I mentioned, I think the cost reductions are overdue, but are going to be hard to do in a sensible manner, in the timeframe discussed. And the reduction in non-core businesses makes a lot of sense (MediaFlo, Mirasol….). What troubles me more is that the company appears to be seriously considering splitting in two. For a variety of reasons, I think this is a bad idea. However, the company is now saying they are considering that possibility. Of course, ‘considering’ something does not mean that it will happen, but it sounded like they were actually setting up a special committee of independent board members to make that call.

The whole thing leaves me a bit confused, and I suspect I am not alone. Conceding to activists normally boosts the stock price, but Qualcomm shares are unchanged since Jana went public with their campaign, and were trading basically flat after hours (not the best indicator). On one hand, Qualcomm is doing a bunch of things that will make the stock more attractive – buybacks, margin improvements, etc. On the other, many investors may read the speed with which they gave in as a signal that conditions are worse than outsiders believed. Certainly this quarter’s results did little to alter that outlook.  

My opinion is that the company’s core business engine – chips, technology and licenses – are still intact and strong. The company is just dealing with the fact that mobile growth is slowing with the law of large numbers. When you have Qualcomm’s market share, it is very hard to grow faster than the market. Still, I think it has a solid foundation, so that it just needs to fix its costs. Nothing they said today change my view on that, except for the fact that they are letting Jana push them around. Are things that bad? The title of my last note was “There is Nothing to Fear but Fear Itself” but I suspect that fear may have been enough.

IPO Series Chapter 6 – “The Process”

KEY LESSON: Be prepared. Decisions made before the IPO can have lasting implications long after the IPO.

In this chapter, I am going to use broad strokes to walk through the IPO process. My goal is to tee up the next few chapters which focus on companies making good first impressions with investors. This chapter is NOT a definitive guide by any measure. The lawyers and bankers provide that, and I lack their expertise. Instead, I want to hit a couple high (low?) points of the process, the key decision making points.

The Early Days

Companies typically find themselves meeting bankers long before they even decide to go public. Good bankers are pro-active, seeking out promising companies, or portfolio companies of prominent venture capitalists who they know. This leads many management teams to think they are well prepared for the IPO, having heard about it from bankers for years ahead of the fact. By this point in the series, it should be clear that this is not the case. To put it delicately, bankers may be pre-disposed to highlight the positive aspects of an IPO.

In the next stage, management teams start to prepare for going public. This is not a final decision, but there is a lot of preparation work required. The CFO brings in the auditors and starts getting the accounting systems up to speed, and starts installing a whole new compliance regime. Costly. Not entirely useful, but a requirement. The auditors then start preparing financial reports that look like actual quarterly filings. Similarly, the lawyers start to get more involved around here and begin handling capital markets questions in addition to the regular business issues about which they have already been advising.

As plans for an IPO get more serious, it is time to pick bankers. The bake-off or beauty pageant rolls around. Multiple banks send teams of people in suits. We walked through this in Chapter 5. Soon after, the company picks its bankers, and the real preparation work begins.

Now come the ‘Org Meetings’, in which all of the underwriting syndicate get together with management to get on the same page. Management gives the bankers a deep dive into the company’s operations. The bankers and lawyers search for their respective hot button issues.

This leads to preparation of the S-1 (or Prospectus) and other SEC filings. My sense is that this drafting process is one of the earliest, time-intensive executive interactions with the IPO process. These things can suck up days of non-stop, looked-in-the-conference-room meetings.  So here’s a PRO tip If you have a really good head of marketing, make sure to involve them. For me, the S-1 is one of the hardest corners to turn in the IPO process. Companies can sound so exciting when they are private, but nothing is as sobering as reading an SEC filing.

Go/No-Go

We have now reached the point of no-return. Companies that file to go public and then pull the IPO often have to wait an extra period of time before being able to file again, or suffer some other form of informal punishment that makes the IPO process harder. So once everything is ready, companies need to make a big commitment.

Assuming that decision is a yes, management teams now begin dipping their toe into the water of public markets.

First, the team holds another Org Meeting with all the research analysts. (This used to be held in conjunction with the bankers, but post-1990’s regulations changed that.) Good analysts often know private company management teams ahead of this time, but this will be the company’s financials’ first impression on the research team. I have seen many IPOs die in this room. Management teams can tell they are in trouble when they post their financial projections and are met with silence. When analysts see numbers their natural inclination is to ask questions. But they are under pressure to be respectful to management teams, so when they see something they do not like, they realize it is better to say nothing. This is one of those moments where the bankers and public markets (in the form of analysts) really diverge. Not all companies will make good stocks for investors. Analysts have to justify their investment thesis on all of their stock recommendations a dozen times a day, so they have a decent sense of what will work. At this stage, the unveiling, analysts want to be helpful, but also recognize that there are limits on what the public markets will accept.

This is a key turning point for the IPO process. The whole point of this series is to highlight the importance of setting expectations. Those expectations are born when analysts first see these numbers. Management teams need to present something that is close to what they ultimately want the Street to expect. The next two chapters are dedicated to how to achieve this.

After this, bankers and analysts will ask for other forms of due diligence in the form of outside reference calls with customers and suppliers. These are usually very straightforward, but I mention this now because it is something that may take some time to prepare, better to think of it early.

The Big Day Approaches

After these are done, the company usually has a big To-Do list with items from all constituents that they need to work through. Once these are done, at some point, management teams and their boards make the final call to file publicly.

This is then followed by more To-Do items, often revolving around the SEC’s response to the S-1 document. But now everyone is expecting an eventual IPO.

Once are the legal items are cleared and the underwriters think the company is ready, it is time for the roadshow.

In this, the management team travels the country and sometimes the world in a very short time period. They present an overview of the company and its financials all boiled down to a one-hour PowerPoint deck. (Obviously, preparation of this deck began far earlier.)

For many executives, the IPO roadshow is a once-in-a-career event. It is pretty horrible from a daily life perspective, but also amazing. The road show usually takes eight to fifteen business days. Management teams give the same presentation to as many investors as possible every day. In Boston or New York, where travel times are relatively short, this can mean giving the pitch ten times a day. Motion is constant. Get up. Go to meet investors. Then the next meeting. Then the next. Lunch, if it comes, is out of a box or two mouthfuls over a lunch meeting where there is too much talking to be done. The day ends with either a dinner meeting with a handful of investors or on a plane to the next city. Repeat.

The road show tests stamina and sanity. It is one of those things that is ‘fun’ in hindsight. And remember every one of these meetings count. Investors are forming their first impressions of management team and building models of what they think the stock is worth. A good road show can have a huge impact on a stock’s valuation. So, no pressure.

And remember, during this two or three week process, management teams are having to finalize their financial filings, and, you know, run their business remotely.

At the end of the roadshow, the underwriters all huddle together the night before the IPO and match investor demand to supply of the stock, setting the IPO price. There are all kinds of complexities here, some of which I will touch on in later chapters. But in reality you can pick your metaphor – smoke-filled room, Black Box, inscrutable cult – somehow the price for the IPO is set. (Ask all your underwriters how it works, but ask them separately and compare their answers. )

Management teams typically spend that night in New York so that first thing the next morning, they can ring the bell at the NYSE or push the button at NASDAQ. Then stock starts trading.

That’s it. Time to get back to your day job.

This is Chapter 6 in “A Practical Guide to IPOs”. You can find Chapter 1 here and Chapter 5 here.

Do we really need to regulate trolls? The law of unintended consequences

I am going to range a bit from my usual subject matter here. I have been thinking a little about patents and all the joy around “Intellectual Property” (IP). But be forewarned, this legal analysis is worth the same amount as my non-existent JD.

Let me say upfront that I do not like ‘patent trolls’, or companies that buy up patents and use them to sue other people. And having seen an IP lawsuit up close, I can also attest that the way we organize IP in this country needs some very serious repair.

So, you think I would be all in favor of US House of Representatives Bill #9 (HR9), also known as the U.S. Innovation Act. (And right away, that name should be a warning.) HR 9 has been presented to the public and the media as “patent reform”, a bill which penalizes “trolls” from harming “innovators”.

And here is where we start to get in trouble.

First, defining a ‘troll’ or an ‘inventor’ is very hard. For example, what if a company invented all kinds of things ten years ago, but today lives solely on license revenue from those inventions? Where do you draw the line? The closer you look, the murkier it gets.

Second, it is not entirely clear that we need a new law to defend against ‘trolls’. There were a number of legal decisions last year that hurt some of the bigger IP firms meaningfully. Infamous ‘trolls’ like Intellectual Ventures is still alive, but has cut back its ambitions quite a bit. Do we need another law if the courts have already fixed much of the problem?

Third, does HR9 really fix the problem? As with most things, could it come at a cost? A key provision of HR 9 is that in a lawsuit regarding a patent, the loser pays the winner’s legal bill. These bills can be measured in tens of millions of dollars. Maybe that sounds reasonable, but one of the things that has me concerned is that HR9 ‘pierces the corporate veil’. Modern capitalism is based on the idea of limited liability. If you are an investor in a company, you can not be held personally responsible for the actions of that company. If the company loses a lawsuit, you the investor do not have to chip in to pay for the penalty.  However, HR9 allows for investors in patent-holding entities to be held liable for losses in a lawsuit.

If you really hate trolls, that may sound reasonable, but there are some ‘unexpected’ consequences of that. What if the person losing the lawsuit is not a troll, but a start-up? As I noted above, defining a troll is very tricky. So maybe a broad reading of HR9 means that any start-up that loses an IP lawsuit with a bigger company can be on the hook for massive legal bills.

One of the saddest things in our legal system today is the fact that an IP lawsuit can cost more money than you would need to raise to start a company. Put another way, the legal bill from a lost IP lawsuit can be more than a company raises from its investors. Add to this, the fact that those venture investors can be on the hook for legal fees above and beyond what they invested, and I think it is safe to say that no start-up is ever going to sue a bigger company if HR9 passes. This would seem to effectively invalidate all start-up IP, since no one would be able to afford to defend themselves.

Like I said, I am not a lawyer, I do not know all the intricacies of this, but it certainly seems possible that HR9 could lead to small companies (aka companies that actually innovate) being punished and having their IP rendered defenseless.

It seems like HR9 is one of those things where strong emotion (against trolls) is being channeled in a direction that creates more problems than it solves.

More Wirless Infrastructure

In my post looking at all the good that Microsoft did for Nokia Networks, I touched on a subject that I want to explore further- the wireless infrastructure market. I know in that post I warned that this was one of the dullest subjects in tech, but I could not help myself. Covering that market day to day can be very dull, but viewed from the perspective of a multi-year cycle there are some important things happening.

In the previous note I said:

I find this level of consolidation, in an immensely conservative industry, to be staggering. I would argue we are likely to see another round of consolidation somewhere down the line. But that is a topic for a different post. 

This is that other post.

First, let me define the market. It is the market for base stations and other pieces of network equipment that connect a cell phone to the Internet. This business emerged as vendors of specialty network equipment for mobie operators. Today there are five companies that really dominate the space:

  • Ericsson
  • Huawei
  • Nokia Networks + Alcatel-Lucent
  • Samsung
  • ZTE

Historically, base stations were worth a lot of money, but with price compression the value has shifted to other parts of the chain. Like so many things, the value here is increasingly being found in the software and integration parts of the sale. As a result, the big equipment vendors are in many ways becoming systems integrators that focus on the telecom vertical.

Selling equipment alone is no longer profitable. Base stations for 2G networks used to sell for $500,000, while today you can buy a 4G base station for as low as $10,000. That sounds bad, and it certainly caused big problems for Lucent, Motorola, Nortel and Siemens. But Ericsson barely slowed down. The remaining players in the space have  found other ways to deliver value to their operator customers. This has largely meant switching to sales of software, services and integration. That sounds nebulous, but is really not that different from a consumer paying $600 for a phone that only cost Apple $150 to build.

The ability of the remaing five vendors to adapt to this new value chain varies across a spectrum. Samsung, the smallest, is probably the most reliant on hardware. ZTE and Huawei are more weighted to the hardware end of the scale, but no one should underestimate the advances they are making in moving more towards software and services. Huawei, in particular, has become very active in promoting various open source software communities. This is classical strategy, destsbilize a rival’s competitive advantage by creating replacements.

In fact, another trend shaping the industry is the fact that the network iteslf is changing. Once upon a time we had different kinds of networks – a network for telephone companies, a network for cable companies, a network for academics, a network for governments, and a bunch of networks for businesses. Each of these had their own standards and suppliers. Today, we are pretty much down to two networks – Telecom (and cable) access networks and the Internet. Telecom operators, especially mobile operators, still spend a lot of money building their networks and thus get to design ‘custom’ gear for their industry, but pretty much everyone else uses the same gear.

I do not want to stray into the land of abbreviations, but if I did, here is the point where I would mention SDN and NFV.  Let’s not go down that path. Instead,  I will leave it with we are very likely seeing a move towards a complete compression of network types. It is very possible, that a few years from now, every type of network will run on the same sorts of equipment. The exact shape that takes is still very much up for debate, but the underlying trends are pretty clear.

For the big five telecom suppliers, this likley means that one of their big defensive barriers will disappear, and new entrants will start storming the citadel of operator capex dollars. Maybe those new entrants will be software companies running on commodity hardware, or maybe those new entrants will be named Cisco and HP.  Too soon to tell, but this will be one of the more interesting spectacles to watch in technology over the next decade.

This does not mean that the telecom majors are doomed. But I do think it will prevent them from enjoying any stability. Even the strongest of these companies, Ericsson, has some big holes in its product categories. These holes are big enough that they will likely either have to pay up for some big acquisitions (JNPR? FFIV? BRCD?) or end up being acquired themselves (very, very unlikely).  Nonetheless, Ericsson has the resources and relationships in the industry, it is hard to see them exiting. There is also the possibility that they jump a step ahead of everyone else taking computing in a different direction. They have not been standing still.

By contrast, Samsung looks very small. They have made a lot of progress in recent years, coming out of nowhere. I also think the parent chaebol sees this as a big addressable market for them to partially replace the inevitable decline of their handset business. So they have the motivation and resources to stick with it. Unfortunately, their product line is sub-scale and generally lacking in software. I think they either make a big acquisition bet or eventually fade away.

Huawei and ZTE have significant technical resources to stay in the race. They also have significant… how to put this…Institutional Resources which can back them up. For instance, their ability to get a $10 billion line of credit from China’s State-run banks to help customers finance equipment purchases. I think people tend to lump these companies together too often. They are run very differently, with very different corporate cultures. My sense is that Huawei is much further ahead in building software stacks, while ZTE has a much broader enterprise distribution channel. So maybe they eventually go their separate ways.

That leaves Nokia Networks (+ Siemens + Alcatel + Lucent), the company which sparked this series. If you line up all of the combined companies’ products, my guess is that you would find there are still some significant gaps in their line up. Importantly, Alcatel-Lucent does have some very interesting networking software initiatives. But right there is the problem – how do we line up the combined companies products? The deal probably does not close for another year, and then the real work begins. What gets cut? What gets fully funded? Integrating companies is complex and can be painful. Adding to the problem is the fact that Alcatel itself probably never fully digested Lucent. The Lucent acqusistion carried all kinds of baggage with it. My guess is that they are still working out accounting and compliance questions from ten years ago.  The combined company is going to look unstable for a number of years. So even though I celebrated their survival in my last post, I have to wonder how much longer they will remain independent.

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