It’s not often that a machine comes along with the claim of being able to supercharge the movement of massive data flows, such as Internet traffic. But that’s what Alcatel-Lucent (NYSE:ALU) is now trying to tempt major Internet service providers into buying. The company is a European manufacturer of telecommunications equipment and through its 2006 acquisition of Lucent, the owner of the world-renowned Bell Labs R&D operations.
As reported in Businessweek and elsewhere this week, ALU recently announced a new router, the 7950 XRS. While that might not sound like a big deal, this router is nothing like the one you might have in your home or office. The 7950 XRS is a core router, used by telecom companies and ISPs to move massive amounts of customer data. ALU’s new version is capable of slinging 6.4 trillion bits of data per second. To put that in perspective, one of these can keep 70,000 HD movie streams, or 8.4 million retail cloud sessions going — simultaneously.
And that’s the base model.
The 7950 XRS, which was three years in the making, is a big deal because the amount of data being moved online has exploded. Online video is hitting 50% of consumer Internet traffic this year — and internet traffic in general has grown at a tremendous rate, with much of the increase coming from the proliferation of smartphones, tablets and other Internet-connected devices, along with the push to cloud computing. ISPs and telecom companies are under pressure to keep up with demand.
When it comes to core routers, two companies currently dominate this $4 billion-a-year industry: Cisco (NASDAQ:CSCO) and Juniper Networks (NYSE:JNPR). Together they control roughly 80% of the market. Convincing customers to switch from their existing platforms to new hardware is a tough sell, but Alcatel-Lucent feels the time is right.
When a core router can’t keep up with traffic demand, users experience slower load times for Web pages or slower downloads. And when a streaming video stutters, a videoconference freezes or a Web-based (cloud) application stops responding, you can bet the complaining will be loud.
Telecoms are facing rapidly increasing demand on their networks, and existing core routers from current providers can’t compete with what Alcatel-Lucent is offering. Alcatel-Lucent’s new 7950 XRS moves data at about five times the speed of Cisco’s fastest core router. In addition, ALU claims its core router can cut energy use and space requirements by 50% because a single unit can handle the traffic that would require as many as 10 linked units from the competition.
Even with compelling performance, it won’t be an easy sell for Alcatel-Lucent. However, it has broken into a similarly tough market in the past. In 2003, it introduced so-called edge routers (used by ISPs to direct customer Web queries to core routers), primarily going up against the same competitors the 7950 XRS aims at, and Alcatel has since grown its market share in that area to 24%. That made it the second-largest edge-router vendor worldwide in 2011.
Assuming Alcatel-Lucent is successful in breaking into the core router market and even achieves the 25% market share it’s flirting with in edge routers, will that have a significant impact on its bottom line?
The European tech company has been on a five-year roller coaster, with its stock dropping from $14 in 2007 to $1.47 a few weeks ago, a near all-time low. ALU has undertaken a series of layoffs during that time (6,000 managerial and contract positions in 2008, 850 in 2009 and a further 1,800 this year), a significant chunk of its workforce. Yet revenues remain below 2007 levels, and 2011 was its first profitable year in recent memory.
A 25% market share in core routers equals roughly $1 billion in revenue. While obviously a win, it wouldn’t even bring ALU back to its 2007 revenue of $17 billion. The company has been focused on cost cutting: those layoffs, selling a call center operation and pursuing licensing deals for the 29,000 patents it holds.
However, with a $4 billion market cap, an international presence, a large patent portfolio, core competency in a growing telecommunications sector and a new product set to challenge networking heavyweights, ALU might make an attractive acquisition. In fact, as recently as 2011, it was considering spinning off or selling its enterprise business unit.
Another company that’s been in the news recently might make a good match if ALU were seeking a suitor: Hewlett-Packard (NYSE:HPQ).
This may not be as far-fetched as it sounds. The two companies are already in a strategic alliance. HP’s latest financial results showed a stagnating PC and printer business, while its services division continues to struggle. The company signaled a renewed focus on enterprise servers, storage and networking — it wants to provide the infrastructure for cloud computing and virtualization.
HP has the server iron, but it lacks the router capabilities to compete with the likes of Cisco. HP’s $42 billion market cap is 10 times ALU’s, and it paid over $10 billion for Autonomy last year, showing it’s willing to make bold moves (not that they all pan out).
Mind you, HP’s cash reserves are currently around $325 million, so the idea is probably moot. In the meantime, analysts have mixed feelings about ALU, with most recommending a hold, and the rest pretty much evenly split between sell and buy, although the stock did get a near 5% boost after the 7950 XRS announcement.
As of this writing Brad Moon doesn’t hold any securities mentioned here.