Merely months after unveiling its software-defined networking (SDN) strategy in January, Juniper Networks (NYSE:JNPR) put some of those plans in action by launching its first programmable core switch last week. The new switch, dubbed EX9200, is based on a programmable Juniper ASIC (application-specific integrated circuit) which provides compatibility with not only existing SDN protocols but also new ones as they develop over the next decade. This, the company hopes, will help customers work with new protocols as SDN evolves in the coming years without having to rip out and replace their existing networking gear. As the networking world transitions towards flatter and more scalable software-defined architectures to better accommodate the growing need for data, Juniper is looking to embrace the trend in a way that stops its hardware business from being commoditized completely.
The new SDN strategy, as outlined in January, entails a more flexible pricing wherein instead of selling expensive gear with built-in software at an upfront price, Juniper will sell the gear first and then the software for a recurring licensing fee in a separate transaction. While the company hasn’t given details about the financial impact of this strategy, we expect this to adversely impact the top-line but margins should improve in the long run. Additionally, a subscription-based business model that relies on stable recurring revenues will decrease the downside risk in a weak spending environment like the one the networking industry finds itself currently in.
The overall networking industry is currently under a cloud of uncertainty due to macroeconomic concerns surrounding the Euro debt crisis, which are showing signs of receding but haven’t yet subsided completely. Concerns over the macro environment are also taking a toll on competitors Alcatel-Lucent (ALU) and Cisco (NASDAQ:CSCO) with the latter doing slightly better than the rest. Still, we continue to be positive about Juniper’s outlook as the long-term trends of data growth and mobility remain strong, which the company should be able to capitalize on as its new products gradually gain more momentum. We maintain our $25 price estimate for Juniper, about 30% ahead of the current market price.
Data demand grows despite macro concerns
As long as the macroeconomic conditions remain uncertain, Juniper’s customers are likely to remain cautious with capital spending. However, Juniper said during the January earnings call that it expects service provider spending in the U.S. to continue and that it is seeing signs of improvement in EMEA spending. While Juniper’s guidance for Q1 2013 isn’t very rosy, it implies y-o-y growth of about 3% at the midpoint – much better than the decline of 6% seen in Q1 results last year.
It is however too early to say if business and service provider spending on network infrastructure has returned. This uncertainty is an industry-wide concern, with even industry heavyweight Cisco maintaining a conservative stance while setting quarterly expectations. These macro concerns have however had little impact on data demand which continues to be strong driven by the key trends of mobile Internet and cloud computing. Data center traffic, which grew to approximately 1.8 zettabytes in 2011, is expected to quadruple by 2016.  Mobile data traffic is also growing exponentially by almost 70% every year and is expected to grow 13-fold in the next five years, according to a new Cisco VNI report.
Scalable SDNs needed to support data demand
However, with data needs burgeoning, the networking world is undergoing a paradigm shift. Enterprises and service providers are demanding more programmability and therefore flatter networking architectures that decouple software from hardware so that they decrease physical complexity and allow networks to scale out through virtualization. The ensuing commodification of hardware however endangers the traditional business model of networking vendors such as Juniper that have relied on hardware complexity to drive margins. Juniper’s SDN strategy can ward off the hardware commoditization threat by relying on tried-and-tested protocols such as Border Gateway Protocol (BGP) while embracing network virtualization that SDNs promise through interoperability with public standards like OpenFlow and other protocols that might come up in the future. Its recent $176 million acquisition of Contrail Networks, which enables IT employees address network issues virtually rather than in person, fits in well with this strategy.
We expect the company’s operating expenses to remain high going forward as Juniper continues to invest in R&D to enhance its SDN platform as well as to come up with new versions of its core router and switching products. The T4000 and PTX core routers launched in 2011 have done well so far, and the new line of EX switches, MX edge routers and the ACX Universal Access product family should help Juniper continue to win clients in a fast-changing environment. We also see Juniper’s recognition of the SDN threat and its coming up with a strategy to counter that to be a big positive going forward. Meanwhile, the company is freeing up cash by streamlining operations and cutting jobs which will bring about operating cost savings of about $150 million annually.
- Global Cloud Index Forecast Update, 2011–2016, Cisco, October 23rd, 2012
Disclosure: No positions