Cisco’s Nexus Can Regain Data Center, Cloud Share, Says Jefferies

Jefferies & Co. networking analyst George Notter today reports on having met with Ishmael “Ish” Limkakeng, who runs the Insieme data center switching effort at Cisco Systems (CSCO), a visit that reassured him about Cisco’s position in data centers and the cloud.
Notter, who has a Hold rating on Cisco shares, and a $29.50 price target, writes the company is “executing” very well, he writes, and may win back some business lost to Arista Networks (ANET) and to so-called white box switching equipment:

Based on our conversations, we remain very confident in Cisco’s positioning within the Data Center Switching market. Overall, it feels like the organization is executing exceedingly well in this business. We expect that – on the back of the Nexus 9000 product cycle – the organization will be able to hold, or even improve, its market share in the Data Center Switching business over time. Below, we’ve outlined number of the key takeaways from our conversations [...] The BroadCom-based version of the Nexus 9000 is performing well also. The strategy of building a higher performance, higher port density Data Center switch is paying off – customers can deploy the Nexus 9000 while getting a no cost “insurance policy” of sorts.

Cloud computing operators are seeing limitations with white boxes, he notes:

While White Box certainly remains a threat to Cisco (and Arista) among these ICP customers, a number of ICPs are feeling the inherent difficulties associated with adopting the technology. Specifically, White Box solutions tend to force the ICP (or any customer) into a “technology integrator” role.

And custom-build cloud computing switches are having a hard time being re-used:

Separately, we note that internally-developed Switch solutions (such as Facebook’s “Project Wedge” Top-of-Rack switch) remain centered on a very narrow set of applications. As such, it’s difficult for an Internet Content Provider to take a solution like Project Wedge (which Facebook recently contributed back into the open source community via the Open Compute Project) and use it for their own purposes.

Arista is actually much more exposed to cloud than is Cisco, he notes — a reason he rates Arista stock a Sell:

We remain concerned about Arista’s business with these customers longer term. The company generates roughly 50% of its sales via Cloud Providers – the most sophisticated buyers of Ethernet Switches in the world. Moreover, they’re getting 27-28% operating margin across the business – these types of margins are inconsistent with this customer base. Over time, Arista could feel margin and revenue pressure from these customers via alternative solutions like White Box or internal-development. In Cisco’s case, the organization generates roughly 5% of its $14 billion/year Ethernet Switching business with the ICPs (or roughly 1-2% of company revenue). It’s a very small exposure.

Even better, Cisco is having success selling customers on “ACI,” or application-centric infrastructure, its vision of programmable networking:

Cisco ended the April quarter with 2,650 Nexus 9000 customers and 580 ACI/APIC customers. Internally, they’re very happy with these results. The ACI/APIC version of the 9000, in particular, is tracking ahead of their internal expectations. This is good news. As we’ve said previously, there’s a lot at stake here for Cisco. If they can’t convince customers on the merits of ACI (and the Cisco ASIC-based architecture in general), the Data Center Switching market devolves into a price-per-port game with White Box solutions setting a low reference price versus Cisco. Limkakeng noted that over half of the 580 ACI/APIC customers are proof-of-concepts (this has been a big area of inquiry from investors). The comments make sense – Cisco grew this 580 figure from 300 Q/Q and customers typically take 2-3 months trialing the system before production deployments. As such, they have a lot of POCs out there. Also, it jives with Arista’s recent comments that they aren’t really seeing ACI competitively right now. Limkakeng commented that these POCs – for the most part – will turn into full-blown ACI implementations.

ACI is helped, he writes, by the fact the alternative, “software-defined networking” is “complex, the standards are still getting solidified, and interoperability between vendor solutions remains tenuous.”
Cisco stock today closed down 4 cents at $29.31.