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.