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Facebook stepped in it this time

Posted on | by Narola

Whether you’ve joined the #deletefacebook camp or not, it’s hard to deny that Facebook has dug a deep hole for itself this time.

Yesterday’s NYT report was a harsh assessment of the company’s trustworthiness. It’s worse when combined with the late September news that Facebook had “exposed the personal information of nearly 50 million users”. These two reports – and a range of more brutal looks at the company – highlight the risks of trusting any large company with your data, much less the volume and sensitivity of data which Facebook demands. For a company that relies almost entirely on advertising for revenues, this is serious.

Immensely profitable. Still.

Let’s not cry for Facebook though. It has had an incredible run. The company’s 12 month revenues have grown from under $30B in 2016 to over $50B for the period ended September 2018 (figure); even the relatively modest 31% YoY growth recorded in 3Q18 far outpaces most tech companies.

Facebook’s growth has delivered high profitability rates, whether measured by net margin (38% annualized in 3Q18) or free cash flow to revenues (34% in 3Q18). Its excess cash has allowed it to invest in both capex and internal R&D at relatively high rates. Facebook’s capex deployment ratio (capex to revenues) is now higher than most telecom operators, at 23%.

You could also argue that Facebook’s high rates of proprietary tech investments (R&D) and capex spend on strategic infrastructure (mostly data centers) have driven earnings – not the other way around. In reality, it’s probably been a virtuous circle for FB so far, but that has always remained dependent on its incredible growth rates in usage and ad dollars. As Facebook’s advertisers see millions of users quitting or spending less time on the platform, clicking on fewer ads, and turning fewer of those clicks into transactions – they will find new outlets. Amazon is counting on it, in fact, with its recent foray into ads, and it’s been successful so far.

(For more on Amazon’s strategy, see MTN Consulting’s Webscale Playbook: Amazon).

Effect on vendors

As the figure above hints at, Facebook spends big on the network infrastructure behind its business: for the first nine months of 2018, its capex on Network, IT & Software was $4.47B, about half of the company’s $9.6B total capex. Any slowdown in growth will eventually hit network spending.

Even if Facebook does some development in house, now including chips, it still buys lots of tech (hardware and software). Some companies & markets to watch:

Servers: Facebook works with several contract manufacturers in Taiwan for production, including Quanta Computer, Wistron, and Wiwynn. These companies may see the effects of any slowdown first, if new server orders fall due to slower traffic growth rates, and/or new data center opening dates are delayed.

Chips: as discussed in a previous blog, Facebook made the big decision to self-develop earlier this year. That offers a modest competitive threat to Nvidia, Intel, and Qualcomm. The economic and operational incentive to keep building its own chips hasn’t gone away since then. If any privacy concerns can be unearthed in the chip area, though, Facebook will certainly face them. More interesting is potential impact on Qualcomm. Facebook uses Qualcomm’s chips for the social media’s rural connectivity project, Terregraph. This program could be at risk, even after recent trials in Hungary, Malaysia, and Indonesia.

Subsea communications: Facebook is a founding investor/owner of five major submarine cables: Argentina-Brazil with Globenet, two transatlantic cables (MAREA and HAVFRUE) and two transpacific cables (JUPITER, and PLCN). These projects have long planning cycles and probably would not be affected by a FB slowdown. However, Facebook’s current search for the right cable investment in Africa may be delayed, or require more partners (Google, Microsoft and Amazon are also looking at the region)

Optical components: Lumentum, NeoPhotonics, and Applied Optoelectronics are FB’s main OC vendors; for the same reasons cited above, they could face some volatility in demand from Facebook.

Earnings calls over the next few weeks may be revealing.

Source of photo: Facebook

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Can India use 5G to improve local vendors’ position in global supply chains?

Posted on | by Narola

In the six years since India’s last telecom sector reform, operators have made big investments in their networks, the country’s subscriber levels have grown, and prices have declined. 4G is now well established, and fixed line broadband finally has decent prospects .

Local (aka indigenous) vendors have sat on the sidelines, unable to keep up

While telecom has grown in India, local suppliers have not. India has many globally competitive companies in the IT services and software space, such as TCS, Wipro and Infosys. But hardware manufacturing remains a challenge. The bulk of telecom capex goes to foreign vendors, who dominate Indian markets for wireless base stations, transmission equipment, and data/IP gear. Most local equipment vendors, such as ITI, HFCL, and even Tejas Networks, rely heavily on government set-asides.

This imbalance is reflected in trade data. Over the 5-year 2013-2017 period, imports of telecom equipment were an astounding $58B more than exports in India. Imports have been 10x the value of exports, or higher, in the last three years. (Figure 1).

Figure 1

For the 2012-14 timeframe, 4G network equipment accounted for a good chunk of the deficit. Since then, the smartphone boom has driven deficits higher. Indian regulators started addressing this in 2017, by imposing a 10% duty on smartphone imports. That has been increased twice, and is now at 20%.

The import duties have encouraged foreign device companies to increase local production. That includes an announcement last week from Xiaomi: its supply partner Holitech Technology will build a factory in Tirupati, employing up to 6,000, and producing camera modules, transistors, touch screens, flexible PCBs, and sensors. This adds to Xiaomi’s already significant local production in India. Samsung, Huawei and others also have facilities.

However, even with some handset production now done in India, much of the value added still comes from overseas. Per Ministry of Commerce trade data, parts account for 30-40% or more of total telecom equipment imports (in value). High-end components for handsets are one part of this. The same issue arises with production of network equipment (e.g. routers): even when produced locally, many of the component parts are imported. That includes semiconductor content in particular.

Further, when foreign vendors set up factories in India, it’s generally to sell gear into local markets, not for exports. There are notable exceptions to that, some in the network infrastructure space: for instance, Ericsson’s Pune plant exports microwave gear to Africa, Southeast Asia and other markets. But the value of these exceptions are small, relative to the huge volume of locally produced & sold gear.

Regulators try again: TRAI’s latest report

As India’s telecom deficit has grown, the government has not ignored the problem.

In Sept. 2017, the Telecom Regulatory Authority of India (TRAI) issued a consultation paper, on the topic of promoting local manufacturing of equipment. The paper addressed the trade deficit issue, and highlighted as the primary cause “relentless” competition from China, “known for large-scale production and export of low-cost equipment”. Imports from Sweden, Finland and America were secondary factors.

Earlier this month, the TRAI concluded its inquiry on the topic. The final report is a comprehensive assessment of the factors limiting India’s ability to compete in telecom equipment markets. The document is impressive as an analytic effort. It identifies a wide range of factors & prescribes recommendations in each area: from university training to patent protection to customs reform to the creation of a number of new boards and agencies.

However, it lacks focus. It suggests doing a bit of everything, and with little new funding: for example, the TRAI’s recommended “Telecom Research and Development Fund” (TRDF) would be equipped with $170M at the outset. That’s better than the status quo, but hardware startups are expensive. One of the smaller US venture capital funds focused mainly on communications technology, Kodiak Ventures, manages $681M or roughly 4x that of the proposed TRDF. The most promising India-based startups are not likely to work with a government VC fund that cannot offer competitive levels of funding and other support.

5G is an opportunity, in theory

In the near term, one intriguing opportunity for vendors – whether local or not – is in fixed broadband, where FTTx rollouts are underway at several companies, including Jio, Bharti Airtel, and BSNL. In the longer term, the shift to 5G is a far bigger opportunity.

While India was late to 4G, policymakers hope to change that with 5G. As India’s Telecom Minister, Manoj Sinha, stated recently, “We missed [the] 2G, 3G, and 4G bus but we are not going to miss [the] 5G bus. A lot of work has been done in our department” to ensure that.

India’s Telecom Secretary, Aruna Sundararajan, has been outspoken in saying India should embrace 5G aggressively, not just for services but to help develop India’s export sector. She is also plugging C-DOT as a technology developer. At the MWC event in Barcelona this year, she met with a number of global tech vendors, commenting that “all the players are positioning themselves for India as a big 5G market. One of the leading chipset [suppliers] in a meeting told us that India will have one of the biggest IoT user base[s] and the company is keen to partner with C-DOT for developing various IoT solutions.”

Beyond enthusiasm, the government is making some modest direct investments in 5G. For instance, C-DOT announced in Feb 2018 that it would set up testbeds in Delhi and Bangalore, led by Anurag Gupta (who attended MWC for C-DOT). The goal is to set up the testbeds in phases, starting with the first in Dec. 2018. C-DOT also signed agreements in June 2018 with three UK universities to conduct joint 5G R&D in several areas, including massive MIMO and mmWave.

In addition, India’s IITs recently announced a 5G commitment from the Telecom Department. Press reports suggest a budget of ~$75M, supporting the work of around 200 engineers.  The IIT 5G project will create testbeds across all 5 IIT campuses. At its Delhi campus, IIT will also work with Ericsson on a new 5G “Center of Excellence,” focusing on massive MIMO R&D.

C-DOT could play an intriguing role

The TRAI report suggests creating several new boards and councils, some multi-agency. To a skeptic, this sounds like a recipe for delay and indecision. That same skeptic might wonder if India already has a well-established organization charged with the development of local telecom equipment production.

The Centre for Development of Telematics (C-DOT) is an autonomous agency of the Indian government focused on R&D in the area of telecommunications. It has just over 1,000 employees across two main R&D campuses, in Delhi and Bangalore. C-DOT develops technologies & licenses them to both government-supported entities such as ITI, and local private sector companies like Tejas Networks.

C-DOT’s employee count has grown in recent years, and it has picked up the pace of its transfer of technology (ToT) announcements. Recent policy changes give C-DOT the charge to seek out overseas business more actively.  Under the government’s “Synergy Plan” released in January 2018, C-DOT is to work with ITI and Telecommunications Consultants of India Ltd (TCIL) on future exports of products & services. That includes granting a manufacturing license to ITI for C-DOT’s terabit router.

Several C-DOT partners, including ITI and BEL, are actively looking to increase exports with the help of C-DOT product. C-DOT executives have appeared recently at public conferences, making a direct pitch to help Indian manufacturers increase exports.

R&D wholesale model, limited funding both need to be addressed

While C-DOT has potential to contribute to 5G and other areas, it is currently viewed as merely a government R&D institute, in effect a wholesaler of R&D to local vendors. C-DOT’s manufacturing partners are responsible for implementation and customer support. To thrive, C-DOT will have to participate more fully in individual projects, getting their hands dirty and talking to customers. After all, many vendors – notably Huawei – include R&D engineers in all aspects of the process, through field deployment and maintenance. India’s vendors can’t just rely on an R&D outsourcing body, and one which licenses its products to multiple players. For C-DOT to help Indian industry drum up more overseas business, functional changes will be needed, along with significantly more funding. As a reference point, C-DOT’s entire budget for fiscal year 2016-17 was about $60M. In 2016, Huawei spent $32M on R&D per day.

-end-

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Facebook’s Plan To Design Its Own AI Chips Has Set Alarm Bells Ringing For Qualcomm, Nvidia And Intel

Posted on | by Narola

[Ed. note: see Sept. 2018 publication, Webscale Network Operators: 3Q18 Market Landscape]

Rumors about Facebook’s likely entry in the hardware segment were put to rest after the company posted job openings for chip designers. Facebook was looking for candidates specialized in architecting and designing ASIC and FPGA chips, to help build “custom solutions targeted at multiple verticals including AI/ML, compression, and video encoding.” Facebook has data center applications on the mind, such as live video content filtering, but the company may also be building chips to support its Oculus virtual reality headset and long-planned smart speaker.

Facebook’s chip plans are risky but may bring increased control over supply chain

Facebook’s recent move to make its own artificial intelligence (AI) chips and get a foothold in the hardware segment is a step in the right direction, as it looks to reduce dependence on chip manufacturers (Intel, Nvidia and Qualcomm) while putting a lid on its costs. However, designing a chip is by no means a simple task and not a core competency at Facebook. Matching the performance and efficiency of Intel, Nvidia and others will be a challenge.

Why would Facebook take the risk? It’s loaded with cash ($41.7B in Dec 2017) and used to making high-stakes tech investments. But the chip market is competitive, and Facebook has substantial buying power – it could certainly rely on the open market. Time to market may improve with self-design, for sure. However, another benefit may be more persuasive: Facebook gets greater control over intellectual property rights and information flow. It likely has a few surprises in store.

Big technology investments needed to support social networking

Facebook’s growth has been driven by acquiring and strengthening complementary services to its social networking business, such as WhatsApp and Instagram. Supporting this growth enticed Facebook to build a huge core network.

Like other webscale providers, Facebook works with contract manufacturers to build custom servers and other gear for their massive data centers. Facebook has played an important industry role in this regard, serving as an early sponsor for both the Open Compute Project (OCP) and Telecom Infrastructure Projects (TCP). Now Facebook is testing the waters in consumer electronics markets, initially with its Oculus virtual reality headsets, a smart speaker to be launched in 2018, and complementary AI software. These efforts have contributed to both high capital spending and R&D expenses at Facebook (Figure 1).

Facebook believes that creating its own custom designed chips will result in better integration of hardware and software, and give it tighter control over the development of the product. One factor behind Facebook’s chip push is an interest in running AI algorithms in-house, to avoid sharing with third-party vendors like Intel or Qualcomm. Not every webscale company can do this, but Facebook is positioned better than most due to its deep capex budget & its pioneering work at the OCP, TIP, and other groups.

Working in Facebook’s favor is its recent partnership with Intel to manufacture its own AI processor last year.

Impact of Facebook’s entry into the semiconductor space on the big chipmakers

In the past two years, there has been growing tension between the tech players building cloud networks and the vendors they rely on, mainly Intel, Qualcomm, and Nvidia. Historically the largest cloud builders, “webscale network operators” (WNOs) in our terminology, have heavily relied on Intel’s microprocessors and Nvidia’s GPUs to power their data centers (Figure 2).

However, Facebook is not the only WNO to look at building its own chip. Many webscale providers are starting to look in-house to build custom AI chips to reduce costs and improve on efficiency. For instance, Google developed an AI chip, Cloud Tensor Processing Unit (TPU), two years back, to boost its AI workloads. Google released a latest version this month, indicating that Nvidia’s dominance as a supplier of AI chips could soon be in jeopardy. Similarly, Apple plans to build its own chips for its Mac desktops by 2020, thus reducing its dependence on Intel. Amazon is building its own custom hardware to improve its Alexa enabled devices. Microsoft has launched a new cloud service for image-recognition projects powered by its FPGA technology, codenamed “Project Brainwave”.  This will rely on Intel Stratix 10 chips and support a neural network based on the ResNet-50 architecture. Microsoft claims that this new technology will be capable of handling AI tasks rapidly enough to be used for real-time jobs and at a reduced cost in comparison to the graphics chips (e.g. NVIDIA) used in machine learning tasks.

As webscale tech players build more of their own chips, traditional chip developers are getting nervous.

One company affected in a big way by Facebook’s move is Qualcomm. Facebook’s new chips may be used to power its VR headset, Oculus Go, which currently runs on a Qualcomm Snapdragon 821 chip. This could be a huge blow for Qualcomm. And it comes at a time when Qualcomm is already struggling after its legal battle with Apple, an attempted acquisition from Broadcom, and a still-pending merger with NXP.

The chip vendor’s fears are not just theoretical. Webscale players have already had an impact on the supply chain, hurting server vendors like IBM and HPE in past years by going to white box/contract manufacturing. Now they’re big enough to design their own chips. That cuts out the middleman, avoids having to share secret IP, maybe speeds time to market, and may result in some proprietary advances.

Facebook will have to win back faith amidst data privacy scandal

While Facebook engineers will continue to find ways to make their network cheaper and smarter, the company faces more complex challenges in the area of data privacy & public perceptions.

Facebook’s privacy practices have come under global scrutiny in recent months, due to the recent Cambridge Analytica and Android call data scandals, not helped by a photo tagging-related lawsuit. As a consumer-facing brand with plans to build its own IoT hardware, a lot is at stake. The company needs to build trust and improve transparency. It cannot do this while also maximizing ad revenue growth. Not all Facebook executives seem willing to accept this.

Amid all the public outcry, the launch of Facebook’s smart speaker has unsurprisingly been delayed. With recent news that Amazon’s Alexa has some interesting privacy-related glitches, Facebook’s decision is probably best. Now seems like a good time to focus on the basics.

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Alibaba’s revenue growth from cloud rises steeply, as it looks to outdo Amazon and Microsoft

Posted on | by Narola

Top US-based tech providers Amazon, Alphabet/Google and Microsoft dominate the cloud space but they are set to face stiff competition from China’s leading cloud provider Alibaba.

MTN Consulting tracks these and similar operators of webscale (aka hyperscale) cloud networks as part of its “Webscale Network Operator” (WNO) market segment.

AliCloud launched nine years ago, now going global

Alibaba established its cloud computing division in 2009, three years after Amazon launched AWS, and went global by 2015. The Chinese company has set up data centers across the Middle East, Singapore, Japan and Europe through its cloud division (Alibaba Cloud, also known as AliCloud or AliYun). It has been ambitious from the start. In 2015, Simon Hu, President of Alibaba Cloud, predicted the company would surpass Amazon by 2019: “Our goal is to overtake Amazon in four years, whether that’s in customers, technology, or worldwide scale.”

Simon’s goal may have sounded a bit far-fetched then, but with a whopping 118% YoY revenue growth from its cloud segment in 4Q17 (as shown in Figure 1), Alibaba is beginning to live up to its ambitions. While still small on an absolute basis, Alibaba has a history of rapid, aggressive expansion into new markets – it is a serious player in the cloud now.

Figure 1: Webscale network operators’ 4Q17 cloud* revenues (in US$B) and YoY growth rate

Source: company filings

Key takeaways from 4Q17 results

Fourth quarter earnings for top WNOs revealed continued strong growth overall, along with some competitive & strategic shifts. Highlights for the top few providers:

Amazon’s sales hit $60B in 4Q17, up 38% YoY, backed by strong sales in the holiday season, and its net profit was also up 148% in the same period. However, operating margins were low for Amazon’s North America segment, which in FY2017 generated just $2.8B in operating profit on revenues of $106.1B. Amazon Web Services (AWS) is a different story. AWS is Amazon’s cash cow business as it continues to generate profit for its group, despite incurring losses from its international segment. As shown in Figure 1, AWS segment’s 4Q17 revenues were $5.1B (up 45% YoY). In the same period, AWS’ operating profit was $1.35B (up 46% YoY) and was also a major contributor to the company’s overall profitability.

On an annual basis, the AWS segment recorded revenues of $17.5B in 2017, (up 43% over FY2016) and now contributes to about 10% of the company’s sales, from just 3% in 2011. AWS’ operating profit for full-year 2017 was $4.3B (with a margin of 25%), much higher than the 3% margin recorded by Amazon’s North America retail segment.

Figure 2: WNO 4Q17 cloud operating profit (US$M) and margin (profit as % of revenues)

Source: company filings

Microsoft’s revenues from Intelligent Cloud* were $7.7B in 4Q17, up 14% YoY. The majority of Intelligent Cloud revenues come from Azure, which grew by 98% during the same period. Intelligent Cloud operating profit was $2.8B, up 18% YoY, giving the division an operating margin of 36% (Figure 2). A key differentiator for Microsoft is its hybrid cloud strategy, which aims to help enterprise users exploit their legacy IT investments. It hit the right note with its acquisition last month of storage vendor, Avere Systems. This acquisition will further enhance Azure’s enterprise capabilities, as Microsoft can merge Avere’s storage capabilities into its own Azure cloud services. That will enable large and complex high-performance workloads to run in Azure.

Alibaba’s cloud computing segment recorded strong revenue growth in 4Q17 (up 118% YoY) but continued to incur losses from this division (Figure 2). In the same period, its cloud segment incurred an operating loss of RMB793M ($122M), and a negative operating margin of around 22%. Unlike Amazon and Microsoft, which generate a good chunk of profits from their cloud segments, Alibaba’s continual losses from its cloud segment are a reminder that its focus is on growth and not profitability. With a free cash flow (operating cash flow – capex) of over $7B in Q4’17, Alibaba has enough cash to plow into its cloud business.

Alphabet’s overall 4Q17 result was promising. Its 2017 corporate revenues crossed $100B for the first time, posting $32.3B in 4Q17 alone. This 24% YoY growth was mainly due to advertising and mobile search. For the first time, Google disclosed its cloud revenues, a little over $1Bn in 4Q17. That figure is lower than that of AWS and Microsoft Azure, but Google Cloud is relatively new. Alphabet has spent over $30B in capex in the last three calendar years, the bulk of which went to its data center and subsea cable network. Alphabet aims to leverage this investment far beyond search. It continues to connect new regions to its Google Cloud Platform, with data centers opening in the Netherlands & Montreal, Canada already this year. The GCP’s network now has 15 regions, 44 zones, and over 100 points of presence.

Alibaba will retain an advantage in China, and is now eyeing global expansion

The cloud computing business in China has long been dominated by domestic players, as the US tech giants find it difficult to make inroads due to the strict laws around censorship and content regulation. The recent stringent law around cross border data transfer will only make life harder for foreign cloud companies, as they are required to store data locally. That will benefit Alibaba, as well as the smaller cloud operations of Baidu and Tencent.

Further, the government restricts foreign ownership of cloud services in China, as they can provide services only via a partnership arrangement with domestic cloud providers in China. For instance, AWS is currently operating in China by partnering with Beijing Sinnet Technology (Sinnet), as AWS is banned from operating under its own brand name in China. In Nov 2017, Amazon sold its hardware to Sinnet, as the law prohibits foreign companies from owning technologies for cloud services. Along similar lines, Apple and Microsoft are currently operating in China through Guizhou on the Cloud Big Data (GCBD) and 21Vianet Group. With US cloud companies forced to wade through tricky regulatory waters in China, Alibaba again benefits.

Alibaba has invested heavily in expanding its network of data centers, and is developing its own proprietary technologies for the AliCloud (Figure 3). As part of its global expansion, India is an initial focus. This will not be easy, as Amazon is clearly the leader in the Indian market. And with Amazon’s failed attempt to flourish in China, the company has all the more reason to defend its turf in India. However, Alibaba has deep pockets and ambitions, too, as it launched a new data center in India in Dec 2017 and in Malaysia recently.

Figure 3: Self-developed infrastructure for the Alibaba Cloud

Source: Alibaba’s 2017 Investor Day.

At the recently concluded Mobile World Congress (MWC) in Spain, Alibaba made clear its intentions to compete in European cloud markets. At the event, AliCloud introduced several new cloud offerings aimed at HPC (high performance computing) workloads, and AI and other data-intensive workloads. To establish a supporting technology ecosystem in Europe, AliCloud is partnering with Vodafone Germany, the Met Office UK and Station F (a France-based startup company). Alibaba hopes to make commercial progress with these new services, and showcase its capabilities in the fields of AI and big data. Ultimately it aims to leverage innovations in these fields across multiple industries. AliCloud’s global expansion is off to a good start.

*Note: For this analysis, we have considered AWS revenue for Amazon and Google Cloud for Alphabet. For Microsoft, we considered total revenues for its Intelligent cloud segment, as the company does not report stand-alone revenues for Azure.

 

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Microsoft & Google pressure Amazon’s prime spot in the cloud; Apple may be prepping for entry

Posted on | by Narola

After a decade of dominance in the public cloud market, Amazon’s top spot came under immense strain in 2017. Years of investment in networks & cloud services began to pay off for Microsoft’s Azure and the Google Cloud Platform (GCP). Apple is also making noises in the cloud.

Tides shifting in 2017

At year-end 2016, Amazon’s Amazon Web Services (AWS) was the public cloud’s market leader, as it had been for many years. Per the Cloud Security Alliance, in 2016, AWS had a 42% share of the public cloud application installed base, Azure had 29%, and GCP had 3% (as did IBM’s SoftLayer).

Capex spend has been strong at Amazon’s rivals for many years, though, and it appeared to pay off in 2017.

As shown in the figure below, capex has grown at all three since 2012, but faster at Google and Microsoft. Each of these “webscale network operators” (WNOs) spend capex on items unrelated to the cloud, for instance Amazon’s fulfillment centers, or Microsoft’s retail outlets. But the big driver in the last few years has been cloud capex, concentrated around construction (or expansion, or retrofitting) of data centers, and supporting infrastructure such as data center interconnect.

MTN Consulting - cloud capex WNO

All this cloud investment has created an intense rivalry, with the new entrants pushing hard on Amazon’s top spot. Large and medium enterprise customers (such as Target, Apple, Dropbox, and Spotify) are now looking at alternatives, including a partial shift from Amazon to other leading cloud service providers. Amazon’s loss of such enterprises from the AWS fold has hurt operating margins, not just topline growth.

Microsoft’s “not so soft” approach appears to be hurting Amazon’s AWS margins

Amazon’s AWS unit has continued to grow fast in 2017, but at declining rates: year-over-year (YoY) revenue growth for AWS was 42% in 3Q17, down substantially from 3Q16. By contrast, Microsoft’s Azure revenues have grown at an average of more than 90% in recent quarters (chart, below).

MTN Consulting AWS-Azure rev grate

More important, after margin declines in 2016, Azure saw improvement in the last two quarters. As the chart below shows, Microsoft’s “Intelligent Cloud” (Azure) margins have improved YoY for the last two quarters, while AWS margins did the opposite. The two companies’ margins converged somewhat in both 3Q16 and 3Q17, but Microsoft’s overall level is safely higher. 

MTN Consulting AWS-Azure margins

To support Azure’s growth, Microsoft has invested on multiple fronts, including acquisitions. For instance, the company recently acquired Cycle Computing, a startup software developer that allows businesses to run apps in the cloud, a lucrative business for cloud vendors. As Cycle Computing has been a long-time partner with AWS and Google, Microsoft gets some new customers out of this acquisition: the existing Cycle Computing customers on AWS and Google Cloud will be asked to migrate to Azure, along with the future customers.

Microsoft has also invested heavily in network capex, partnering with such vendor suppliers as ADVA (100G optical for DCI); Cisco (Cisco Cloud Services Router 1000V); Ericsson (IoT accelerator); Huawei (a jointly engineered server product for hybrid cloud apps on the Azure Stack); Mellanox (40G Ethernet switches); Qualcomm (evaluating the new Qualcomm Centriq 2400 processor for cloud applications); and, many others.

Cloud is one of Google’s three big bets

Google Cloud Platform, the tech giant’s cloud division, currently lags far behind AWS but is trying to catch up. The renewed focus on cloud is a result of Google exploring growth outside its core advertising business. This continues to grow nicely, but remains highly vulnerable to economic headwinds.

Google’s CEO Sundar Pichai says “Cloud” is among the top three bets of the firm going forward. Unlike Microsoft, Google does not break out revenues (or report margins) for its cloud business separately. However, we know that GCP is a big part the company’s growing “Google Other” segment, which was 12.3% of total revenues in 3Q17 (3Q16: 10.8%). Google’s CFO Ruth Porat confirms that GCP is a main driver for growth in this segment. One metric of GCP’s growth is the number of big (>$0.5M) cloud deals signed per quarter; the total in 2Q17 was 3x the total for 2Q16.

To support this growth, cloud-specific investments have increased significantly in 2017; overall capex was $3.5B in 3Q17, up 39% YoY, benefiting server manufacturing partners Inventec & Quanta Computer. Cloud opex is rising as well, due to new cloud technical & sales staff hires.

Google racks PRY_20

Google’s push into the cloud market is only a few quarters old

The moderate gains made so far by Google in the cloud market are impressive, considering they just started in 4Q15, with the appointment of VMware co-founder Diane Greene to head its cloud business.

Prior to Greene’s appointment, Google was mostly perceived as the Internet search and advertising giant, which struggled to market cloud solutions to enterprises. The perception has since changed a bit, with GCP’s aggressive pricing strategy and incremental market gains. The GCP got a big boost in September 2017 with a win at Salesforce. Earlier this month, Google made another important hire: Diane Bryant, Intel’s former datacenter unit head, is becoming the COO of Google Cloud.

With this impressive team, Google is now looking to outperform AWS by 2022. Five years is ambitious, but not impossible. To succeed, Google is looking to position itself as a cloud solutions provider for AI- and Big Data-based applications, as these two technologies are considered as next big key adopters to cloud. Google is starting to reap some results from this new positioning. For instance, it recently struck a deal with Zebra Medical Vision to host its AI algorithms on Google’s cloud.

However, Google has to do much more than enticing big-ticket enterprise customers to switch. For rapid growth, and to support an AWS-like breadth of offerings, Google would need a sizable acquisition. Google’s biggest acquisition so far has been Motorola for US$12.5 billion. It would be looking to make a similar-sized acquisition in the medium term to help catch up to Amazon. Per the rumor mill, Salesforce and Workday are options, among many others.

 In the long run, Apple’s project “Pie” could eat into Amazon’s “share of pie”

While Amazon is focused on Microsoft and Google in the short to medium run, Apple may be secretly beefing up its own cloud capabilities to battle Amazon in the long run.

Currently, Apple’s role in the cloud has been mostly in the SaaS space through its iCloud service. However, a number of indicators point to Apple pursuing its own cloud computing strategy beyond SaaS; for example:

  1. Secret restructuring of its cloud computing operations under a project code named “Pie”: This includes moving the infrastructure for Siri, iTunes, Apple Music and Apple News onto a single proprietary cloud platform called “Pie”.
  2. Reduced reliance on other cloud operators to run its iCloud and other services: Apple is having issues relying on other cloud providers, as slow networks and outages disrupt Apple’s services. In late 2015, Apple started exploring how to build its own cloud infrastructure and end dependence on other cloud players completely, through “Project McQueen”.
  3. Increased investments around data centers: in 2017, the company announced two massive data centers in Iowa and Nevada, with construction costs of US$1.3B and US$1.0B respectively.

All the above specifics clearly suggest Apple aims to make a foray into the cloud market. But by no means guarantee it. Apple does not enjoy being predictable.

Amazon fights back

Amazon is not sitting back in face of these threats. The company is adopting a three-pronged strategy of “Innovate-Invest-Collaborate” in the cloud.

As the cloud pioneer, AWS continues to “Innovate”: expanding cloud platform functionalities from 280 new features in 2013 to 1,000 new features in 2016; launching a joint innovation center in Qingdao, China in 2017; rolling out a the AWS Snowmobile, Snowmobile.6824c527b221bfcd0fc284a04576b23d0d5edc1fwhich is a physical data transfer service using a 45-foot long container on a truck. That’s for transport to and/or between AWS data centers. Amazon also continues to “Invest” in (or acquire) cloud-related companies, including cyber security company Harvest.ai in January 2017, Thinkbox Software in March 2017, and GameSparks in July 2017.

The “collaborate” aspect of Amazon’s strategy involves collaboration with rivals where Amazon is weak. For instance, Amazon announced a surprise partnership with Microsoft in October 2017, to launch a free software tool for developers, Gluon, which allows them to build AI and cognitive systems. The alliance is seen as countering Google’s TensorFlow tool, which is already popular among developers. In 1Q17, Amazon teamed up with rival VMware to develop software to help companies move on-premises applications to the public cloud. These moves are significant for Amazon, as it looks to counter its peers in specific product segments in order to maintain its #1 position and lift margins.

For more information about MTN Consulting’s coverage of webscale network operators, please email us.

(Photo sources: Google & AWS)

 

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Understanding The Carrier-Neutral Market (And Why Revenues Will Pass $40B This Year)

Posted on | by Narola

MTN Consulting has just published a “Market Review” of the carrier-neutral network operator (CNNO) sector. The report assesses the key role that these tower, data center, and bandwidth specialists are playing in the downsizing of the telecom sector. While many telcos are shrinking, the CNNO sector is growing >10% per year. Revenues for the 25 CNNOs we track should surpass $40B this year, and approach $60B by 2020 (Figure 1).

mtnc-cnno revs through 2020

Takeaways from the study include:

  • CNNO revenue growth has been steady around 10-15% YoY for several years, in line with the growing telco (& other provider) need for low cost, carrier-neutral network resources. 3Q17 revenue growth for CNNOs was 13.1% (Telco Network Operators: 1.0%; Webscale Network Operators: 23%).
  • CNNO capex rose 11% YoY in 3Q17, to $3.6B. Tower specialists spent 24% of their revenues on capex, data center specialists over 43% due to higher (and lumpy) investments in developing new sites. Tower providers’ incremental capex in new sites is primarily for small cells. Bandwidth specialists’ capital intensity has been over 50% for the last 5 quarters, due to the influence of new builds (NBN in particular).
  • CNNO capex hit $15B on an annualized basis in 3Q17; the biggest spenders were Equinix, Level 3, Australia’s NBN, Crown Castle, Digital Realty, American Tower, and Zayo.
  • M&A is a big factor in the sector’s growth, but just one. CNNOs are growing organically too, and expanding their business models to require a broader mix of equipment (Crown Castle is looking at edge computing, for instance). Technology-related operating expenses can be quite high, for repairs & maintenance of old plant, and energy costs in particular.
  • Total capex across telecom, Webscale, & CNNO was $355B in 4Q16-3Q17 (Figure 2).

mtnconsulting 3Q17 capex-summ5

The report also assesses CNNOs’ network holdings across four main categories: fiber, data centers, towers, and small cells. Most big operators have assets in multiple areas, and that will increase over time. Tower companies are building small cells, for instance, while bandwidth specialists are extending their fiber routes to small cell sites.

Table 1 provides a snapshot of the infrastructure assets for a sample of the CNNOs covered in this report.

Table 1: CNNO network assets (excerpt)

mtnc cnno1

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Telco capex in 3Q17 up 4% YoY (preliminary); what’s in store for 2018?

Posted on | by Narola

Not all telcos have reported, but a large sample (of 60 companies) has spent US$50.2B on capex in 3Q17. That’s up 4% year-over-year (YoY), after adjustments for acquisitions.

A 4% growth rate for telco capex is relatively high by recent standards (Fig. 1). LTE spending declines have plagued YoY capex comparisons since 2015. In this same time frame, the Webscale sector – led by Alphabet (Google), Amazon, Apple, Facebook, & Microsoft – has increased capex by double digit percentages in most quarters.

Source: Company filings. Preliminary results of 60 telcos (ex-China), and 17 webscale providers

Looking forward, Webscale sector capex will continue to grow much faster than telcos, by 5-15% per year. The outlook for telco capex remains challenged, however.

Weak top-line growth not just a short-term problem

In 3Q17, telco revenues grew just 0.8% for the sum of the 60 companies we’ve captured to date. That pushed down the annualized growth rate to under 1% (Fig. 2).

Source: Company filings. Preliminary results for 60 telcos. China excluded from the chart

Telecom operator revenues have been challenged for several years, and it’s not a regional problem, or one that will go away soon. Many telcos are facing margin squeeze as subscriptions decline in key areas (e.g. consumer broadband), & mobile churn remains too high. Telcos like KDDI and (many) others are investing in new service areas based, for instance, on IoT. Seeing a return from these investments has been slow, though.

3Q17 results & operator plans

Capex for our group of 60 was $50.2B in 3Q17, up 3.6% YoY. That pushed annualized capital intensity for the group to 15.3% in 3Q17, up slightly from 15.2% a year ago. (Note that the sample of 60 excludes China).

As telcos move to more software-based networks, most aim to keep a lid on network spending – at least, the capex component of network spend. That was clear from 3Q17 earnings calls, for instance:

  • Telefonica says its “radical network virtualization” helps to optimize capex, enable faster deployments, and incorporate big data into network planning. Its capex has been in the 16-17% of revenue range steadily since 2014, though, without a noticeable decline. Looking ahead, Telefonica suggests a “distinctive declining capex trend” will be needed to drive growth in free cash flow and reductions in net debt
  • NTT projects capex of 1,700 Billion Yen for the fiscal year ended March 2018. That’s flat year-over-year. But the last 6 months of the year (4Q17-1Q18) will fall YoY, from 1,034B Yen to 942B Yen.
  • Deutsche Telekom’s 9.24B Euros in capex so far this year is up nicely (+12%), but the company projects capex in its core market of Germany to be flat through 2021 at around 4.3B/year; only regulatory relief would bring any upside.
  • Comcast’s capital intensity was 15.6% in 3Q17, but will average 15.0% for the full year. The company is under pressure from rising content costs (despite ownership of NBCUniversal; AT&T, take note!).
  • Orange is spending €7.2 billion on capex this year, from 7.0B in 2016, with a practical focus on raising 4G & FTTx coverage. Fiber investments helped Orange grow its base of “very high-speed broadband” customers to 24.6M households in September, up 46% YoY.

Not all bad news for vendors

The telco shift to more virtualized, software-driven, open sourced networks is real, and it will bring many benefits, but it doesn’t guarantee lower capex. That’s in part because it’s a very gradual shift for most. Big telcos with millions of subscribers & thousands of employees do not change processes that quickly. Many big operators are raising capex, or at least keeping levels flat despite revenue declines. At the global level, though, a 5-10% drop in telco capex is likely next year. The changes by technology area & region will be more extreme; more on this topic soon.

A side note on this week’s news: AT&T-Time Warner and net neutrality

Two major events took place in the US this week: the US Department of Justice (DoJ) announced it would file suit to block AT&T’s purchase of Time Warner, and the FCC made clear it would soon be gutting net neutrality provisions. What’s the impact on capex?

The AT&T situation is too complex & politicized to assess yet. I was never a big believer in the merger, in part because of Comcast’s troubles, within an (already) integrated content-cable group. It seemed a big gamble, given AT&T’s lack of history in content, and limited experience with large cross-sector acquisitions. It also would clearly distract the company during a time of industry upheaval. So, if the merger falls apart, it wouldn’t be the worst thing for AT&T. In the meantime, I would not be surprised if it targeted a bit more of its total capex overseas, in Latin America, pending more certainty.

Regarding net neutrality, my two cents: the FCC’s new rules will have approximately zero impact on US telecom capex. They may change the distribution by company slightly, and you can be sure Verizon, AT&T and others advertise loudly any investment that can be positioned as “new,” and incented by the FCC rule change. But that’s marketing, not reality.

(Photo credit: Jason Blackeye)

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Indian Operators Divesting Tower Assets To Raise Cash

Posted on | by Narola

Faced with tough competition and high debt, Indian telecom operators are spinning off their tower assets to investors or independent tower companies to improve their financial situation. The 2016 sale of Tata Teleservices’ tower business (Viom) to ATC, and RCom’s planned sale of its tower unit (Reliance Infratel) to Brookfield are just two examples.

Operators in many other regions have divested towers to raise cash, not just India. This is part of an ongoing trend, enabled by the maturity of independent asset management companies. Such divestments in India, though, come against a backdrop of urgent debt reduction needs. Funding network capex while navigating this transition will be a challenge.

Do operators really gain from tower divestments?

Though operators benefit from a cash influx after an infrastructure sale, the devil is in the details. Tower sales typically come with long-term leaseback arrangements, with pre-determined pricing levels locked in. Operators need to set aside sufficient funds for recurring rental costs.

There have been instances where tower companies have shutdown service to operators following rental defaults; RCom is one case. Since the details of the outgoing rental costs incurred by operators are not revealed, it does question the merit of the tower sale. On the other hand, many towers remain underutilized, and operators see benefits not only from the initial sale but in lower ongoing costs as tower space is shared. It also helps them avoid new tower construction, hence avoiding some capex (all else equal).

In India, mobile operators increasingly are focused on their main telecom business, relying for tower assets on a mix of dedicated private equity firms and pure tower infrastructure companies. Deals continue to happen. For instance, now that Vodafone’s acquisition of Idea Cellular has been approved by the antitrust regulator, Bharti Infratel will likely try to buy Vodafone’s 42% stake in Indus Towers. It’s also possible that, post-merger, Vodafone/Idea’s combined 20,000 towers will be acquired by ATC.

Below are a few cases of Indian operators selling towers, or their holdings in tower subsidiaries. Two are completed deals, one is in progress, and two are still under discussion.

Tower asset transfers are affected directly by the broader services market, and M&A changes at that level. We’re seeing this now in India. Vodafone’s merger with Idea, for instance, set to complete in 1H18, is forcing a realignment of ownership in Indus Towers. RCOM’s hoped-for big payout from its tower sale to Brookfield is now in question, since the RCOM-Aircel merger collapsed. Meanwhile, Jio continues to push aggressively to expand, keeping margin pressure high on rivals.

Mobile market consolidation might free up capital for network expansion

In the wake of heavy competition and high debt, Indian operators are exploring various financial deals, not just asset spinoffs.

The recent Tata Teleservices (TTSL) sale of its mobile arm to Airtel, and Vodafone-Idea merger, may just be a silver lining for the Indian telecom mobile market. Over the next five years, we might see a drop in the number of mobile players from 9 to 5. Such consolidation should be beneficial for operators, which can merge network and spectrum holdings. That would free up more capital to invest in network expansions and upgrades; recently Indian operator capex has dipped. Tata Communications’ capital intensity (capex/revenues) averaged just 9.5% for the last three fiscal years, for instance.

With growing demand for a complex range of new mobile services (including in the IoT space), there is a strong argument that operators shift tower management to independent, specialized companies, and focus on providing better quality of service and coverage. India may soon provide a test for that argument.

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Weak network spending climate becoming more apparent

Posted on | by Narola

Fidelity’s “Communications Equipment” index is up nearly 11% so far this year, tracking just a few points behind the S&P 500’s YTD gain of about 15%. Looking ahead, though, the communications equipment sector remains challenged, something 3Q17 earnings are making clear.

Ericsson, Nokia and ZTE in a similar boat

Vendors selling mainly to communications markets are reporting sluggish demand. In 3Q17, revenues declined by 4% and 9% YoY at the networks divisions of Ericsson and Nokia, respectively (for Nokia’s trend, see figure below).

Multiple regions are seeing the same issue: weak telco revenue growth is constraining more rapid investment. LTE networks are in place, ready for growth & upgrade via software (mainly). Fixed broadband networks remain expensive to construct, and the video revenue upside is proving to be a challenge for many operators, including AT&T.

ZTE doesn’t break out carrier revenues on a quarterly basis. Corporate revenues fell 5% YoY in 3Q17, and ZTE says carrier demand is stronger than average. We’ve estimated 1% YoY growth for ZTE’s carrier group in 3Q17, in local currency. The China capex outlook is cloudy, though, something which both ZTE and Huawei will have to face next year. They also, I suspect, will reinvigorate their vendor financing programs, as has already come up in Brazil with a potential buyout of Oi with involvement from the China Development Bank.

The figure below confirms, though, that it’s not just ZTE, Ericsson and Nokia facing issues. Many suppliers reported YoY revenue declines in 3Q17.

3q17v2

Accenture’s result is modest evidence that telcos continue to increase spending on services & software, but not definitive as Accenture includes telecom in a larger Communications, Media & Technology (CM&T) vertical.

Adtran’s growth is due largely to an acquisition, namely of CommScope’s active fiber access product line, in late 2016.

Corning’s growth is more interesting. Many vendors are reporting a shortage in actual fiber optic cable supply over the last year or two. New factories or expansions have been announced by Corning, Furukawa, and most recently Prysmian. These tend to tie in to specific large telco (or national government) fiber builds, as with Verizon’s FiOS and the NBN in Australia. The economics of these builds require video service profitability, in general, and that has been mixed lately.

Telco capex datapoints not reassuring, but it’s early

Many telcos have reported already, including Rogers & Verizon, Telefonica, Orange, America Movil, AT&T, Telenor, and DoCoMo. Occasionally a big operator reports capex growth, unapologetically – referring to the revenue opportunities that might come with that. DoCoMo comes closest to this model so far. Its capex for the last two quarters is up 9% YoY, in part to support new services in the “Smart Life” business. Most, though, are talking down capex, emphasizing that the bulk of 4G work is done, fiber capex is more targeted & tactical than 2 years ago, etc.

On Telefonica’s 3Q17 earnings call, for instance, COO Angel Vila noted that:

“CapEx is on a declining trend in Spain. We have already 97% LTE coverage. I think it’s close to 70% fiber-to-the-home coverage. We will continue deploying fiber, but reduce speed and focusing on connecting… the CapEx trend in Spain is already declining in terms of CapEx to revenues.”

Many operators have similar stories. Vendors will have to seek out the ones with more budget flexibility. Even with some success, though, it’s likely we will see a pickup in M&A activity around the communications equipment sector over the next 1-2 years.

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First Few 3Q17 Telecom Vendor Reports: YTD Revenues Down 3.4%

Posted on | by Narola

If you’re looking for a capex bump in the telecom sector, results for 3Q17 so far won’t reassure you.

The vendors that have reported are not seeing much growth. For six vendors (or divisions) with high exposure to telecom, annualized revenues continued their decline in 3Q17 (figure).

vendor-1

On a nine month (year to date) basis, revenues for this same group were $33.2B, down 3.4% from $34.4B in 1-3Q16.

This is not a random sample, just a view on the early reporters. Many more significant vendors in the sector have yet to report. However, the weak spending trend is consistent with what many vendors have been reporting for several quarters. It’s also consistent with operators cutting their capex targets.

The figure below shows YoY % change in revenues for each of the 6 companies/divisions, for the last five quarters.

vendor-2

The steady negatives at Ericsson are concerning, as is the 3Q17 decline at ZTE. That could signal weakness in China, where operators were already guiding down capex projections. Juniper’s telecom/cable revenues declined, but that was one point of the vendor’s recent segmentation, to highlight growth differences: its “Cloud” segment is up 16% YTD.

Adtran’s growth is due partly to its CommScope acquisition, so hard to decipher. Wipro is a small services/software player in telecom, and hasn’t been helped by a weak Indian spending climate. Corning, though, is reporting steady YoY growth in optical communications segment revenues, noting yesterday “especially strong demand” for its carrier products, where Verizon is an important customer.

More to come soon, as more vendors report.

(Photo credit: Maarten van den Heuvel)