Software Defined Networking Moving Towards Mainstream

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1 Electronics Banking Research August 2012 Software Defined Networking Moving Towards Mainstream Key Takeaways: Edited by Kirk Bloede Software Defined Networking (SDN) has emerged as a promising new approach to transform traditional networking to better handle the exponential growth in data traffic, network virtualization, and mobility. SDN has gained significant market momentum in the last few quarters, and it appears that the hype of SDN has escalated to a fever pitch. Recent headlines have included the market launch of Big Switch Networks in early 2012, and VMware s (VMW) acquisition of privately held Nicira for $1.26B and Oracle s (ORCL) acquisition of privately held Xsigo last month. As large networking equipment suppliers and large software suppliers race to build their SDN Story we see the potential for further acquisitions and consolidation to occur over the next few quarters. We view SDN as a long term threat to traditional hardware- based networking equipment suppliers as new SDN entrants emerge and price points likely fall. Over the next few years, we see traditional hardware- based networking product gross margins deteriorating in the data center. After several years we could see the start of entire network functions in the data center and service provider WAN being supplanted by lower cost virtual switching and routing networking functions hosted on standard off- the- shelf servers. We see incumbent switching equipment suppliers Cisco (CSCO) and Juniper (JNPR) with the most to lose. SDN Market Update SDN is a new network architecture where the control plane and data planes are separated. The use of a centralized network control and a common communication layer protocol across various network elements can enable faster time to new feature deployment and troubleshooting, increased network efficiency, centralized traffic engineering, and the ability to build multiple virtual networks running over a common physical network fabric. Common networking functions such as switching and routing can be implemented on standard server technology. OpenFlow has emerged as the leading standards- based protocol used by network elements use to communicate with each other in an SDN environment. We believe it has taken several years and a confluence of events to get SDN to where it is today. Industry Research from Woodside Capital Partners 1

2 We believe for years, incumbent networking equipment suppliers such as CSCO and JNPR delayed supporting SDN as it represents a potentially disruptive shift from higher price hardware- centric designs to ultimately software implementations of switching and routing functions on servers. We believe that multi- core server technology now supports high performance, real- time processing and virtual switching functions at lower costs compared to commercial silicon or custom ASIC based hardware platforms. We believe that the development of a robust intercommunication protocol standard (OpenFlow) has now emerged with which vendors can now design products to a common set of requirements. Major service providers already see applications for SDN, initially in the data center and ultimately migrating to the WAN network over the next several years. Among significant service providers backing SDN, Verizon (VZ) and Google (GOOG) appear to be the most vocal proponents of SDN, with GOOG recently announcing its data center interconnection traffic is already running on a self developed OpenFlow based network and a custom hardware platform. Although GOOG has proved OpenFlow can operate in a controlled production environment, we believe GOOG spent significant resources developing its own software for this custom application which likely lacks compatibility with other network applications. We view the GOOG application as a good proof of concept for SDN and the OpenFlow protocol, rather than a commercially viable solution. Although equipment suppliers are now developing SDN controller functions, implementing OpenFlow support, and developing virtual switches, we believe it could take nearly two years for SDN to start to gain widespread market adoption. We believe much of the technical implementation issues have been solved, but presently there are no equipment suppliers that offer the entire range of products and turnkey services which we believe will be key to driving SDN into mainstream data center applications. We expect this will be solved within 1-2 years. Equipment Suppliers Implications As SDN begins to gain widespread adoption in the next few years, we see the following equipment supplier implications: SDN should help level the playing field among smaller competitors against CSCO, but we do not see an immediate significant disruption in switching market share. Rather, after 1-2 years we expect traditional switching equipment suppliers such as CSCO, and to a lesser degree JNPR, to start to see prolonged price and gross margins erosion as these products compete with low cost software switch alternatives. CSCO has announced its SDN development initiative (via its spin- in project called Insiemi) to develop new silicon and hardware systems, but the timing and product deliverables remain unclear. We expect CSCO s near term data center sales to remain strong. JNPR claims SDN- like functions in many of its products already and has announced support for OpenFlow in 2013, but we do not believe it is Industry Research from Woodside Capital Partners 2

3 developing a server based switching platform which we believe necessary to compete on price and functionality in the SDN architecture. On the surface DELL and HP (HPQ) appear to be developing longer term plans to productize SDN to compete head- on with CSCO, but we remain skeptical. Dell has a limited track record in internal development of advanced software features and it appears more focused on further software acquisitions to bulk up rather than address cutting edge technologies such as SDN. We believe HPQ lacks the internal talent to develop an advanced SDN feature set and with its balance sheet in shambles is no position to acquire its way into the SDN market. IBM certainly has the resources to develop or acquire its way into SDN, but we believe it could pressure JNPR to develop a complete SDN product ecosystem, leveraging the IBM sales channel and IBM professional services.. IBM s strategic development project with JNPR to build a next generation data center switching fabric (called the JNPR Q- Fabric) has yet to produce meaningful revenue for JNPR or services revenue for IBM, and SDN could be the next step to try and drive this partnership further. While IBM appears better strategically aligned with JNPR, we continue to see strong sales collaboration between CSCO and IBM for the bulk of data center opportunities. We believe that Citrix (CTXS), EMC (EMC), Red Hat (RHT) (with a likely focus on the maturing open flow standard, coupled with its virtual storage solution it acquired with Gluster) and Microsoft (MSFT) could make moves in this area, especially in the area of Software Defined Storage (SDS). SDS could emerge as a longer term threat to EMC s core business, much like SDN is a threat to CSCO. We believe VMW s announced acquisition of Nicira is aimed to help solve key VM management and scalability issues seen in the data center. However we believe with its strong financial footing, dominant channel in the data center and ability to pull together a complete SDN ecosystem, VMW could emerge as a leading SDN player. We do not see any immediate impact to VMW s V- Block data center partnership with CSCO, EMC, and Intel (INTC), but new SDN implementations from VMW in 2013 could spark a serious threat to CSCO and the V- Block alliance. With its acquisition of Xsigo, we believe ORCL s initial thrust will be to round out its Exadata storage solution, but in the medium term we believe ORCL could decide leverage the Xsigo virtual switching platform to compete directly with CSCO and JNPR. Although the Xsigo product delivers an incremental improvement in data center switching technology, it leads us to believe that over time virtual switches could ultimately replace traditional switches. There has been increasing concern that SDN will disrupt the L4- L7 application delivery controller (ADC) market, dominated by F5 (FFIV), CTXS, and others. Our research leads us to believe SDN will likely remain focused on more traditional L2- L3 networking applications for in the next 2+ years. Industry Research from Woodside Capital Partners 3

4 Open Issues We expect further consolidation among the emerging OpenFlow controller suppliers either through acquisition by larger vendors or elimination of substandard players. After the Nicira acquisition, we see privately held BigSwitch and potentially other suppliers such as Contextream and Vello Systems as likely acquisition targets. Although we believe OpenFlow protocol could see widespread support in embedded merchant silicon, we remain unclear as to the long term benefits to leading suppliers Intel (INTC) and Broadcom (BRCM). Although there is significant market backing of SDN and OpenFlow, our research suggests that currently there are several issues that need to be addressed prior to widespread adoption: The OpenFlow flow protocol is being used in limited production environments, but the standard lacks sufficient maturity needed for widespread usage. SDN could take several years to mature fully and meet broad application requirements. Support for OpenFlow in merchant silicon has been significantly delayed. Silicon suppliers such as BRCM and INTC remain focused on developing traditional networking functions, but we believe by 2013 embedded support for OpenFlow in silicon will become available. Multi- vendor interoperability will push increased test and qualification resources on service provider and enterprise customers, already strapped for IT resources. We see qualification as a major impediment to mass adoption. We believe large scale ecosystems suppliers such as IBM and VMW are required to take on increased systems integration and test roles for SDN to proliferate beyond niche applications. Our research indicates early implementations of OpenFlow controller functionality do not scale effectively. We believe over the next 1-2 years, network scalability will vastly improve. We believe there are currently only minimal standard applications and features available in OpenFlow. It remains unclear if smaller new entrants, customers, or third parties will contribute to development of the broad library of features required for mainstream adoption. We do not believe traditional service providers are positioned to develop custom software as next generation providers such as GOOG have done. We see the recent acquisitions of Nicira and potential additional acquisitions of smaller technology players as key to providing a commercially viable SDN ecosystem. SDN 101 Traditional networking equipment utilizes an embedded control plane that enables switching, routing and traffic engineering functions while the data plane forwards packet based traffic. (Think of control plane as the traffic manager and data plane as the traffic carrier). In a SDN architecture, key control plane functions are removed from disparate individual networking elements and embedded in a centralized, hosted location on a server. Industry Research from Woodside Capital Partners 4

5 Network elements become more focused on packet forwarding and switching and routing functions, managed by external management and control via a management protocol such as OpenFlow. Through the use of a centralized control plane, service providers and large network operators can achieve several operational benefits. SDN allows service providers to build a logical mesh network with pre- determined backup paths for increased network resiliency and efficiency as well as a common network control point for improved network management. SDN also improves the cost efficiency of network management and upgrades as new features can be tested and implemented via a single change to the controller software vs. upgrading each network element separately. SDN allows network operators to leverage generic, low- cost hardware in place of custom hardware designs. In addition, SDN networking protocols can be run simultaneously as overlay networks operating on a common physical layer of equipment Network operators can achieve increased network performance and reduced cost. As network elements are no longer bogged down in supporting control plane resources, packet forwarding performance will typically increase. Also, packet forwarding elements can be more easily implemented in standard server / processor architectures, driving costs down. Equipment suppliers are now implementing OpenFlow on standard Ethernet switching platforms via custom software, but we believe that over the next few years many suppliers will implement OpenFlow via embedded functionality on merchant silicon. We believe a silicon- based implementation could lead to increased vendor interoperability and to use of standard servers being used as common network elements. Use of off- the- shelf server hardware for SDN functions can best leverage silicon innovation and minimize the risk of obsolescence. After decades of becoming trapped by selection of a single vendor s architecture, SDN is expected to offer multi- vendor interoperability which will limit the high profits typically achieved in the latter stages of product cycles. Industry Research from Woodside Capital Partners 5

6 Companies Mentioned BigSwitch, Broadcom (BRCM), Cisco (CSCO), Citrix (CTXS), Contextream, DELL, EMC (EMC), F5 (FFIV), Google (GOOG), Intel (INTC), HP (HPQ), Juniper (JNPR), Microsoft (MSFT), Nicira, Oracle (ORCL), Red Hat (RHT), Vello, Verizon (VZ), Xsigo Woodside Capital Partners Hardware and Semiconductors Team Rudy Burger Greg Mischou Mike Powell Shusaku Sumida Disclaimer: The Information and opinions in this report have been prepared by Woodside Capital Partners International, LLC and are published solely for informational purposes, and are not to be construed as an offer to sell or the solicitation of an offer to buy any security in any state where such an offer or solicitation would be illegal. Other than disclosures relating to Woodside Capital Partners International, LLC the information herein is based on sources we believe to be reliable but is not guaranteed by us and does not purport to be a complete statement or summary of the available data. Any opinions expressed herein are statements of our judgment on this date and are subject to change without notice. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information Important Disclosures: Woodside Capital Partners International, LLC is not a market maker in any securities mentioned in this report. Woodside Capital Partners International, LLC and its officers and employees may from time to time acquire, hold, or sell a position in the securities mentioned in this report. Woodside Capital Partners International, LLC compensates research analysts for activities and services intended to benefit the firm's investor clients. Compensation determinations for research analysts, including the author(s) of this report, are based on a variety of factors, and may include the overall profitability of the firm and the revenues derived from all sources, including revenues from investment banking. Industry Research from Woodside Capital Partners 6