When Apple's new iPad went on sale this month, it effectively raised the speed limit for a new generation of Internet users. Its 4G wireless telecom technology is as much as 10 times faster than many corporate networks over which it will communicate.
That capability puts upward pressure on consumer expectations for just how fast data should move, and may well tax many existing data centers.
The higher bar is, however, good news for companies that make the gear and systems enabling corporate and telecom networks to keep pace. Those include stalwart gear makers such as Cisco Systems (NASDAQ:CSCO - News) and Riverbed Technology (NASDAQ:RVBD - News). Revenue and earnings growth for some players has been north of 20% in recent quarters.
The need for such equipment has soared as notepads and smartphones press the boundaries of broadband communications. Networking equipment — a basic element of data center construction — is critical for companies, including telecom carriers, attempting to manage rising tides of information being pushed through Internet pipes and wireless networks.
The move to cloud computing services — which allow companies to store and access data over the Internet — is also a factor, says Rohit Mehra, an analyst for technology researcher IDC.
The next five years are likely to see continued rapid expansion of large- and medium-sized data centers, Mehra says, to support cloud-type services.
"It's already quite big," he said, "but this train isn't stopping anytime soon.
The momentum helped lift the Computer-Networking group in February into the top 50 industries tracked by IBD. The group ranked No. 32 Friday, after starting the year with a No. 108 ranking.
1. Business Cisco is the group giant. The company's business reaches into all corners of computer networking ranging from Ethernet switches and routers to Web videoconferencing systems.
Another leader, Riverbed, is the top provider of wide area networks or WAN's that push data across states and continents. Polycom (NASDAQ:PLCM - News), a leading provider of unified communications, competes with Cisco in the Web videoconferencing market.
Netgear (NASDAQ:NTGR - News) makes computer networking gear for small businesses and residential consumers.
Allot Communications (NASDAQ:ALLT - News) and Procera Networks (NASDAQ:PKT - News) also make networking gear for managing data traffic. Both companies compete for business among wireless and broadband network operators and others.
The industry has its hard luck stories. Even in the market upswing, some gear makers such as Brocade Communications Systems (NASDAQ:BRCD - News) and Juniper Networks (NYSE:JNPR - News) have been unable to jump-start their revenue growth.
Of the 29 companies in the computer networking group, shares of only 15 are trading higher than 10.
• The Name of the Game: Computer networking companies compete to sell equipment to telecoms and others to keep wireless networks and data centers humming: innovation, service, price and reliability are all crucial.
2. Market By 2015, global sales of enterprise computer networking equipment including Ethernet switches, IP telephony, wireless local area network gear, application delivery systems and routers will reach $52.6 billion vs. $39 billion in 2011, says IDC.
Roughly 50% of that market is Ethernet switches. Why? Because they are the link between server computers and Internet users. You can't build a computer network to the data center all the way to mobile devices and back without them, says Mehra.
"Companies are building big data centers and sometimes even mega data centers and all of those data centers require Ethernet switches to connect servers and users," he said.
Other areas also show promise. Global sales of enterprise videoconferencing equipment and services will reach $4.7 billion in 2015, up from nearly $2.7 billion last year, says IDC.
Sales of WANs are much smaller, but still growing. By 2015 global WAN revenue will reach $1.4 billion vs. $984.9 million in 2010, IDC says.
Riverbed has the lead in the WAN market. But its revenue growth has slowed through the last three quarters from 35% to 28% and 23%.
The San Francisco-based company is in transition, working to hold ground while it waits for sales of new products introduced last year to ramp up, says Daniel Ives, analyst for FBR Capital Markets & Co.
"It's going through the normal pains of a hypergrowth company," he said. "They saw a massive deal flow coming off of the recession and now its about expanding their market opportunity and further penetrating enterprises.
3. Climate Growth in mobile traffic is one positive for the industry.
Mobile traffic is often measured in exabytes. One exabyte is equal to 1 billion gigabytes.
By 2016 global mobile traffic is expected to reach 10.8 exabytes a month, an increase of 18-fold over 0.6 per month of exabyte usage last year, says a February report by Cisco. In six years Cisco estimates mobile traffic will grow at an annual growth rate of 78%.
Allot is trying to crack the North America market. And both Allot and Procera are targeting strong growth opportunities in Latin America, says Catharine Trebnick, senior analyst for Northland Securities.
"Brazil and Argentina have really strong mobile growth and there is a lot of investment in the development of that by the (telco) operators," she said.
On March 15, Procera said it plans a secondary offering to raise $100 million to plow back into operations.
Other challenges loom.
Cisco continues to work through a restructuring effort launched last year to cut costs and focus on core products. But some core areas, such as switches and routers, are maturing. In its last three quarters Cisco's revenue growth has lagged at 3%, 5% and 11%, respectively.
Cisco has countered by trying to push into new areas such as video services. On March 15, the company said it planned to acquire NDS Group, a software provider to the pay-TV industry, for about $5 billion. The deal will boost Cisco's emerging video business, says Shaw Wu, an analyst for Sterne Agee & Leach. "We believe NDS gives the company a more complete video offering ... ." he wrote in a March 16 report.
Also on March 15, Avaya, a unified communications company, agreed to acquire Radvision (NASDAQ:RVSN - News), a videoconferencing company, for $230 million.
Polycom issued a statement saying it wasn't concerned about the new rival. But it will potentially lose a piece of its business as Avaya uses Radvision products, rather then Polycom and other providers, to fill gaps in its unified communications offerings.
4. Technology As demand intensifies, computer networking companies fight to continually broaden their technology's capabilities.
In late February, Cisco agreed to pay $271 million to acquire Lightwire, a maker of optics chips. The chips could give Cisco an edge in helping clients better manage the growing demands of video and other information in their data centers.
In February, Polycom extended its video collaboration service to Apple iPhone 4S phones and devices using the Android 4.0 operating system.
The effort matches Cisco, which already had a mobile offering for its rival WebEx service.
But the sluice for new technologies may be running dry. Last year, venture fund investments in computer networking declined to $740.7 million vs. just over $1 billion in 2010, says PricewaterhouseCoopers and the National Venture Capital Association.
Funded companies also declined to 103 last year vs. 120 in 2010.
Venture funds are making fewer bets on perceived winners, says Tracy Lefteroff, global managing partner of PricewaterhouseCoopers' venture capital practice.
"The only stuff that is getting funded is breakthrough technology stuff that is pretty capital intensive," he said.
The bet is that those are the companies that Cisco and other large players will pay big bucks to acquire, Lefteroff says. "They are keeping their fingers crossed.
5. Outlook The market for computer networking gear is growing, fueled by companies demanding better ways to manage data. But the industry has its issues and challenges.
• Upside: Data traffic is exploding. The need to manage the growing amount of mobile data is only getting started. Consumer's mobile use is phase one, says IDC's Mehra.
"The next phase of this mobility growth is going to come from the enterprise, when all of these mobile devices and tablets start to access real enterprise applications," he said.
And large companies like Cisco won't be the only ones cashing in as telecom companies shift to building up their wireless networks, says Northland's Trebnick.
"There is conscientious spending going on and companies like Allot and Procera have capabilities to make their networks more efficient with the data deluge," she said.
• Risks: Polycom continues to thrive offshore. More than 50% of its revenue came from Europe and elsewhere in its Q1. But weakness in North America is a factor in limiting its overall revenue growth. For Netgear it's the exact opposite. The company is strong in North America but faces stiff competition in building a bigger customer base offshore.
Cisco also faces competition from Juniper and Hewlett-Packard (NYSE:HPQ - News) in the switching and routing segments.
Riverbed is counting on recent product launches to fend off competition from small and large rivals. But its revenue growth rate is slowing. Some investors are questioning whether the company's best days are gone, says FBR's Ives.
"The bears say the best of the growth is in the rear view mirror so its about proving to the naysayers that they are still in the second and third inning of this growth cycle and not in the sixth or seventh," he said.
