Legacy Telco Vendors Continue To Struggle

I spent Saturday reading through various earnings call transcripts of networking companies, including Juniper Networks (NASDAQ: JNPR) and Nokia (NYSE: NOK).

The main takeaway for me is that legacy telecommunication vendors are blaming a "declining capital expenditure environment in 2016" for their revenue shortfalls.

On the Nokia call, the CEO offered:

After the strong order intake we saw in Q2 across many businesses, it is fair to say that in Q3, we did not see quite the same level of strength, and more broadly, we now believe that our overall addressable market will show a decline for full-year 2016 rather than being flattish as previously expected. As we look forward, we expect market conditions to stabilize somewhat in 2017, with the primary addressable market in which Nokia competes likely to decline in the low single digits for that year.

Not exactly "animal spirits" inducing language, and it sounds more like the softness legacy telco vendors are experiencing is less about declining capex spend at key customers, but more about not having the right technology solutions that CSPs want to spend money on. In my mind, it is a strong confirmation that CSPs are starting the much anticipated transition to the NFV architecture and diverting capex spend to NFV software players like RADCOM (NASDAQ: RDCM), Radisys (NASDAQ: RSYS) and AMDOCS (NASDAQ: DOX) who appear to have the technology CSPs want to buy.

Juniper's CEO confirmed this sentiment on JNPR's 3Q earnings call:

Tal Liani - Bank of America Merrill Lynch

Hey, guys. I want to compare the opportunity in telco's versus cloud, and take a more maybe of a long-term view. So if the opportunity in telco,s, if it continues to decline, is your participation in the cloud opportunity big enough or large enough to offset this? And maybe you can talk about your participation among cloud providers, what kind of products and projects – conceptually, what kind of projects and products you're working on? Thanks.

Rami Rahim - Juniper Networks, Inc.

Sure. Thanks for the question. I think that the cloud opportunity remains robust for the foreseeable future. I mean, at the end of this year and I think into next year, large cloud providers and as well as the second tier cloud providers that are what we call "Born in the Cloud," their business models evolved around the cloud opportunity, are essentially recognizing that their wide area networks and their data center networks are essential to delivering the kinds of experience that their customers demand. And for that reason, I think spending there will be robust.
Telco is a little bit of a different story, and I've been consistent in how I've talked about the telco opportunity over the last few quarters. First, I think just judging by the conversations we have with our telco customers as well as their CapEx reports for the year and how much they've spent thus far, we do expect there to be some spending by telco's in the Q4 period.
Longer-term in telcos, all service providers – or many service providers are going through an architectural transformation. They're really thinking about how to leverage their networks as essentially a distributed cloud network. And we are very pleased with how we're working very closely with our telco customers, who we obviously enjoy a very close working relationship with, to help them with that transformation. And that speaks to our broad portfolio of switching, routing, security and very much around our cloud software, Contrail being a very powerful tool that we have today to engage very strategically with these architectural transformations that are happening at our telco customers.
Summing that all up, I think that for – because of this transformation that's happening, telco's we can expect will divert their focus to that transition and less on just building out their core or their edge networks in the way that they have done in the past. The most important thing is that we remain very engaged, very close with them in the transformation so that we can benefit from the new types of buildouts that they will be deploying. And I think that will start in the 2017 timeframe. So they're going through this shift, and we just have to make sure that we stay very close and we capitalize on the solutions we're offering them to help them with the shift itself.

That response from Juniper's CEO confirms what I have suspected: that CSPs are definitely moving in the direction of building out their NFV architectures, and any caution from traditional TEMs should be viewed as bullish incremental information for NFV software players who are unconstrained by large, legacy revenue streams from technology CSPs don't want to buy anymore. Rather, pure-play NFV software players could see a cascade of new orders as they begin to engage with CSPs who are going down the road of virtualization.

RADCOM is in discussions with 9 Tier-1 CSPs, four of which appear to be accelerating at a rapid pace [we think it is Orange, Verizon, Colt and Vodafone]. There are more in the queue for 2017, and cable operators are likely to line up for virtualized architectures as CSPs begin to encroach on their Pay-TV businesses. Then there is the webscale internet company angle that we've discussed on the blog in the past.

Putting it all together, I'm not worried about broad capex spending cuts from CSPs as it relates to my investment in RADCOM. Rather it makes me more comfortable that RADCOM is positioned to take a greater share of IT capex budgets going forward.

That is a much more "animal spirits" inducing narrative that could lead to a dramatic re-valuation of shares to higher levels as investors start to figure out who the winners and losers will be in this NFV transformation.

Disclosure: I own RDCM shares.