Juniper Wins PEER 1′s Data Center Contract As Demand For Data Surges

by Trefis Team
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With demand for data growing exponentially, enterprises are continuously investing in and upgrading their data centers to provide support for their IT systems. Rising demand for data centers is in turn driving up demand for networking solutions that companies such as Juniper Networks (NYSE:JNPR) provide. The company recently announced that it has won a data center deal from global web hosting provider PEER 1, which has deployed Juniper’s integrated routing, switching and security technology at its flagship U.K. data center. With Juniper’s solution, PEER 1 expects to provide its customers with “carrier-grade performance, reliability and security” while reducing server downtime by 33%. The new data center facility is also more power-efficient than before, with Power Usage Efficiency scores touted to be much better than the industry standard.

However, the overall networking industry is currently under a cloud of uncertainty due to macroeconomic concerns surrounding the Euro debt crisis, which are showing signs of receding but haven’t yet subsided completely. Concerns over the macro environment are also taking a toll on competitors Alcatel-Lucent (NYSE:ALU) and Cisco (NASDAQ:CSCO) with the latter doing slightly better than the rest. Still, we continue to be positive about Juniper’s outlook as the long-term trends of data growth and mobility remain strong, which the company should be able to capitalize on as its new products gradually gain more momentum. In line with this view, Juniper’s stock has risen more than 25% in the last four months and is now about 20% below our $25 price estimate for the company.

See our full analysis of Juniper Networks


Data demand grows despite macro concerns

As long as the macroeconomic conditions remain uncertain, Juniper’s customers are likely to remain cautious with capital spending. However, Juniper said during the January earnings call that it expects service provider spending in the U.S. to continue and that it is seeing signs of improvement in EMEA spending. While Juniper’s guidance for Q1 2013 isn’t very rosy, it implies a y-o-y growth of about 3% at the midpoint – much better than the decline of 6% seen in Q1 results last year.

It is however too early to say if business and service provider spending on network infrastructure has returned. This uncertainty is an industry-wide concern, with even the industry heavyweight Cisco maintaining a conservative stance while setting quarterly expectations. These macro concerns have however had little impact on data demand which continues to be strong driven by the key trends of mobile Internet and cloud computing. Data center traffic, which grew to approximately 1.8 zettabytes in 2011, is expected to quadruple by 2016. [1] Mobile data traffic is also growing exponentially by almost 70% every year and is expected to grow 13-fold in the next five years.

The ongoing economic concerns have therefore only resulted in longer project cycles and extended delivery timelines from customers. Network spending, and therefore Juniper’s revenues, should once again grow as economic conditions stabilize. Service providers, who will need to buy networking gear to support the burgeoning demand for data, account for almost two-thirds of Juniper’s revenue with some of the largest U.S. wireless carriers such as Verizon contributing  as much as 10% for the full year 2012. AT&T, also one of Juniper’s bigger customers, has increased its CapEx guidance by $14 billion over the next four years.

Further, we see Juniper’s recognition of the SDN threat and its coming up with a strategy to counter that to be a big positive. It not only helps mitigate the risk of hardware commoditization but also positions it well for a new trend that has been gaining ground. (see Juniper Unveils New Strategy Mitigating Software-Defined Network Threat)

R&D spend a good sign of continuing innovation

As a consequence of the slump in network spending, Juniper has had to take a margin hit due to the high fixed costs for its innovation business. Its operating expenses increased in 2011 even as revenues dropped due to high levels of R&D investment that the company maintained throughout the year. What we like here is that in 2012 as well, despite the decline in revenues, the management has not cut down on these expenses to boost margins. While gross margins for Q4 saw an y-o-y of almost 200 basis points, operating margins declined as R&D expenses continued to mount.

This is a good sign because thanks to the relentless R&D spend, the company is now seeing market share gains on its new products. The positive impact could be seen in recent quarters but the effect will be even greater when the global economic conditions improve. The new products have also helped increase the mix of higher-margin routing products, thereby bolstering Juniper’s gross margins which have improved more than 300 basis points since the start of 2012.

We expect the new routing products to continue to improve the firm’s overall product mix toward higher-margin routing products, providing support for its declining product gross margins as a result. This impact would however be gradual since new products generally need time in the market to start having a meaningful impact.

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Notes:
  1. Global Cloud Index Forecast Update, 2011–2016, Cisco, October 23rd, 2012 []
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