Deep Packet Inspection: An Interesting Investment Theme

by: Edward Schneider, CFA

Deep packet inspection (DPI) is used in communication networks to filter and analyze digital packets including the header and data body. DPI has been around for many years, but is now becoming a must-have for telecom carriers. The amount of data and video network traffic is exploding. Carriers need tools to monitor and control traffic flows, including the use of price-tiering for heavy users.

The DPI market is expected to grow four-fold from $0.5B this year to $2B in 2015.

I discussed the explosion of mobile bit traffic caused by the proliferation of smart phones in my previous articles including this one, where I stated: Since 2008, carrier mobile revenues have increased 2x globally, while traffic increased 25x. This is not sustainable, and will be addressed in two ways. First, consumers will have to pay more. This will be done via price-tiering such as premium services for mobile video streaming. Vendors that I visited that help enable these services include Tekelec (TKLC) and Bridgewater [subsequently acquired by Amdocs - (DOX)] in policy management and tiered billing solutions, and Sandvine (SNVNF.PK) in deep packet inspection and policy traffic switching. Second, carriers will need to offload traffic. This will be achieved via LTE (but will take time to harmonize standards and for carriers to make major capex commitments), increasing available spectrum, mobile backhaul and via femtocell and microcell technology. I also visited another DPI company at Mobile World Congress - privately-held VSS Monitoring, which mostly focuses on the security side.

DPI and related Policy Enforcement today creates revenues for mobile carriers via traffic price-tiering schemes, while still continuing to improve quality of service and security. The beauty of DPI is that it costs the carriers very little, providing a payback of six months or less. So DPI is avoiding the carrier capex squeeze faced by its telecom equipment brethren, and currently experiencing very healthy demand. This demand will be even stronger once net neutrality constraints in the U.S. are addressed, so that DPI can be fully deployed by U.S. carriers. In fact, Verizon's (NYSE:VZ) move to join AT&T (NYSE:T) to eliminate fixed-price unlimited mobile traffic plans, makes DPI-enhanced price tiering a logical next step.

This price-tiering can be highly customized given the granularity of today's DPI systems. A future personalized mobile payment plan could be:

Jane Doe's Plan

Policy Monthly Rate
My Cap 5GB $25
Overage 1GB $10
Facebook unlimited -----
YouTube optimized $1.50
Skype priority $1.50
Click to enlarge

The three leading pure-plays in DPI and Policy Enforcement are Allot Communications (NASDAQ:ALLT), Procera Networks (NYSEMKT:PKT), and Sandvine (OTC:SNVNF). Currently, Sandvine is the largest, but the slowest growing. Allot is second, and growing quickly. Procera is the smallest, but is growing the fastest. These companies also compete with large network integrators like Cisco (NASDAQ:CSCO) - which acquired P-Cube to enter this niche in 2004.

DPI Pure Plays
Company Ticker LTM Sales Last Quarter Growth YoY
Sandvine SNVNF.PK $99M +10%
Allot ALLT $67M +35%
Procera PKT $29M +102%
Click to enlarge

I spent some time with these three companies. The reason Sandvine (and Cisco) have slower growth and are winning less in the marketplace are their systems are closed. This generally means that to add new services, a customer would have to add more in-line servers, load-balancing, etc. Allot and Procera are able to put this functionality on a single open platform, requiring less equipment, less potential points of failure, less power, and less maintenance. Allot has an additional advantage of offering the most features beyond DPI and Policy Enforcement with such services as URL filtering. Procera, however, has a key technological advantage: scalability and performance under high-stress data conditions. For example, Procera's product literature shows a maximum processing speed of 120 Gbps versus 30 Gbps claimed by Allot.

In practical terms, this DPI/Policy Enforcement box must simultaneously associate packets with location devices, analyze the behavior of those packets, provide billing information and messaging to customers, among other tasks. This may be easy for a few thousand customers simultaneously, but when we move into the millions, this is where Procera excels. It appears that Procera's Datastream Recognition Definition Language flow-based architecture is simply more scalable.

Thus, when scalability and performance in high-stress conditions is the issue, Procera normally wins. Allot does better when customers are looking for a service gateway with additional feature sets. Judging by the growth rates and recent contract wins, Procera is doing a bit better, albeit growing from a smaller base. Procera also has more exposure to the fast-growing mobile carrier market.

We liked both companies but decided to invest in Procera a few months ago. Both Procera and Allot shares have performed well recently. Procera (on November 7th) and Allot (on November 1st) should both report blow-out Q3 numbers with strong visibility for continued growth.

For those readers that would like to learn more, there is the Global Broadband Traffic Management conference in London from November 15th to 17th. All the vendors mentioned in this article will be exhibiting.

Disclosure: I am long PKT.