Earnings reports hint at IP networking growth

As the second-quarter earnings season begins, analysts are expecting good numbers from companies in the networking sector. This is in sharp contrast to the software and semiconductor markets, which are already seeing dismal results at the beginning of this earnings season.

"We are advising clients to shift investments from software and chips to networking ahead of earnings reports," said Erik Suppiger, an equities analyst at Pacific Growth Equities. "In general, we feel networking has had a good quarter. And we expect strong growth in this market to continue through 2004."

On Tuesday, Juniper Networks--the first major networking company to report earnings--started the season off with a bang. The company, which competes with Cisco Systems in the IP router market, reported better revenue growth than expected.

Juniper saw revenue growth of 86 percent to $306.9 million, up from $165.1 million in the same period last year. Despite that, the firm recorded a loss of $12.6 million, or two cents per share, mostly due to the $60 million in expenses related to the NetScreen Technologies acquisition earlier this year.

Some of this quarter's growth came from the addition of NetScreen's products, but roughly 55 percent of the growth was from the company's traditional IP router business, said Marcel Gani, the company's chief financial officer.

"IP routing has been gaining momentum over the past year," said Kevin Mitchell, an industry analyst at Infonetics Research. "Even in 2003, when other technology sectors were down, the router market was flat. In the fourth quarter of 2003, revenues were up 2 percent, and up another 2 percent in first quarter of 2003."

A combination of factors has helped drive this growth, analysts say. For one, traffic on the Internet has been doubling yearly since 2002, according to an Infonetics study published last November. Carriers are also starting to put more of their customer traffic onto a converged network using technologies such as multiprotocol label switching (MPLS).

As technologies merge, industry groups are responding by reorganizing. On Thursday, the MPLS & Frame Relay Alliance, a group of carriers and vendors promoting that technology, will merge with another industry body, The ATM Forum, which has focused on promoting and developing standards for asynchronous transfer mode (ATM) networks.

"It's become apparent over the last couple of years that networks are converging," said Rick Wilder, vice president of technology for the MPLS & Frame Relay Alliance. "Carriers are telling us they need standards and technology to interwork between all three technologies: MPLS, ATM and frame relay."

Rising numbers of broadband subscribers and a shift toward new IP services like Internet telephony are also pushing usage on the Net. In North America, DSL subscriptions rose 12 percent, to 13 million, in the first quarter of 2004 from the last quarter of 2003, according to Infonetics. Internet cable subscriptions grew 7 percent, to 18 million, during this period, the research firm said.

But new growth is only part of what is driving demand. There is also a generational shift under way in the type of equipment needed to build next-generation IP networks.

"To prepare for the conversion to a packet infrastructure, carriers are investing in the latest generation of routers and networking gear that have better quality of service and deep packet inspection," Infonetics' Mitchell said. "These are not the characteristics of IP networks in the late 1990s, when a lot of the current gear in these networks was deployed."

Most analysts agree that Cisco and Juniper will be two of the biggest beneficiaries of this increased focus on IP. Cisco has already invested a significant amount of money in addressing the carrier router market and recently introduced its long-awaited next-generation router, the CRS-1. It has also bought technology from routing start-up Procket Networks.

But some analysts say there is opportunity for some networking companies to get in on the action. Suppiger said smaller competitors in the routing market, such as Avici Systems and Redback Networks, could win more business, as could companies like Extreme Networks that sell to corporate customers.