The biggest profit making trend in networking over the next few years is the shift from physical networks to software defined networks.
The trend is a natural extension from the virtualization of enterprise computing and it offers significant opportunities and challenges for players such as VMware (VMW).
A few years ago, the shift to virtual computers was just picking up steam, and today virtual computing has captured roughly ~60% of the market, with VMware owning roughly 55% share. As virtualization has swelled, demand for busting data silos and replacing them with unified solutions in the cloud has generated billions in sales for VMware.
However, the move toward off-siting data has also shed light on bottlenecks within existing physical networks.
These bottlenecks are driving data centers such as Rackspace (RAX) to move from physical network provisioning to software management solutions.
As a result, there's been a wave of consolidation in the software defined networks ("SDN") space since summer, kicking off with VMware's acquisition of Nicira for over a billion in July.
With Nicira, VMware landed a leader in next generation networking and a platform it can easily integrate and monetize alongside its existing vSphere and vCloud virtualization products.
VMware's acquisition led Oracle to buy Xsigo too. And Cisco (CSCO) just bought vCider this week to help protect its legacy switch business from SDN competition. The move is important for Cisco, because its switches are most likely to suffer from future growth in SDN deployment.
Cisco and VMware have long partnered in providing enterprises with a soup-to-nuts, hardware-to-software solution for virtualization and the cloud. But, the relationship is shifting, much like it has between former friends Apple (AAPL) and Google (GOOG).
SDN's advantage is in removing the reliance on expensive and less flexible switches, like those sold by Cisco and its competitor Juniper (JNPR), by moving network management, such as directing traffic or shrinking latency, to a software based controller instead. This saves money in reducing equipment spend. But, it also saves money in IT labor by making configuration changes simpler.
VMware's Nicira acquisition brought with it high profile customers such as Rackspace and AT&T (T). It also significantly boosts the company's networking chops, allowing it to significantly boost its addressable market from roughly $30 billion last year to some $50 billion in 2015.
Next week, VMware hosts VMworld in Barcelona and you can bet a lot of time will be spent talking about SDNs. Given VMW's shares are 18% off their 52 week high and are flirting with 200 dma support, an entry ahead of the conference may make sense for investors hoping to ride the SDN wave over the coming two years.
For those interested, I've also included Q4 seasonality from the Seasonal Investor database for convenience.