New Technologies and Upgrades Drive Growth in Core Cisco Business
Cisco (NASDAQ:CSCO) dominates the bottom layer switch market with a share of around 72%, [1] followed by other players such as Juniper (NYSE:JNPR), Alcatel-lucent (NYSE:ALU) and Tellabs (NASDAQ:TLAB).
We currently have a Trefis price estimate of around $25 for Cisco’s stock, about 8% above the current market price of $23. Networks switches account for nearly 30% of the our price estimate for Cisco’s stock and we expect that upgrades to newer, faster technologies will drive demand for Cisco’s bottom layer switches.
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Bottom Layer Switch Market Sensitive to IT Spending
Bottom layer switches, which operate at layers 2-3 of the network architecture, have historically seen positive revenue growth except for in the first half of 2009 when sales declined. This occurred as a result of a cut-back in IT spending due to weakness in the economy which persisted during 2008-2009. The market, however, seems to have staged a strong recovery as evidenced by the 15% revenue gain in the Ethernet switch market during Q4 of 2009 and in Q1 of 2010 when sales gained by 12% to $4.6 billion [2].
The bottom layer switch market grew from an estimated $14.2 billion in 2005 to about $16.8 billion in 2008 before declining down to $15.8 billion in 2009 [3]. Going forward, we expect this growth to continue, although at a slower rate during the Trefis forecast period.
Upgrades to Drive Growth
Bottom layer switches are primarily used to balance and direct traffic within a network. The immense growth that occurred during 2004-2006 was primarily a result of an upgrade to Gigibit Ethernet (1 Gbps) from Fast Ethernet (10/100 Mbps). We expect the next major growth to come from an upgrade to the 10 Gigabit (10 Gbps) standard, which will drive a shift from a three-tier to a two-tier network, driven mainly by the need for speed, server virtualization, and unified switching fabrics by service providers and companies. [4]
The bottom layer switch market is maturing, with already an extensive base of network switches. Hence the main source of growth is expected to come from upgrades and the replacement of switches. Both enterprises and service providers are on a cost cutting spree as the weakness in the economy persists through 2010. Consequently, we expect the market to grow at a slower rate in the coming years.
Higher Expectations for Bottom Layer Switch Demand
The average of Trefis member forecasts for Bottom Layer Switch Market Size indicate an increase from $18.7 billion in 2010 to $23.4 billion by 2016, compared to the baseline Trefis estimate of an increase from $16.6 billion in 2010 to $19.4 billion by the end of the Trefis forecast period. The member estimates imply an upside of 6% to the Trefis price estimate for Cisco’s stock.
You can drag the forecast trend-line above to express your own view, and see the sensitivity of Cisco’s stock to the Bottom Layer Switch Market Size.
Our complete analysis for Cisco’s stock is here.
Notes:
- Cisco Bottom Layer Switch Market Share = Cisco Bottom Layer Switch Revenues / Bottom Layer Switch Market Size [↩]
- Infonetics Research: Ethernet switch market nears pre-recession highs; enterprise router recovery taking shape [↩]
- We’ve estimated Bottom Layer Switch Market Size using publicly-released data by market research firms Infonetics Research and Dell’Oro Group. These firms report the estimated market size on a periodic basis [↩]
- 10G Ethernet shakes net design to the core [↩]