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As sales of smartphones soar and companies shift data to cloud computing, the outlook for the makers of the switches, routers and other gear to manage networks may not be as gloomy as recent share market performance suggests.
Pent-up demand from the recession years drove up industry sales by around 30 percent last year, but recent warnings from network gear makers that they face weaker business and government spending have battered their stock prices.
Juniper Networks (JNPR-N) -- which, like market leader Cisco Systems (CSCO-Q), makes equipment for wireless carriers to smooth the flow of data by spreading it across a network -- has seen $3 billion US wiped off its market value in one day. Shares of Brocade Communications Systems Inc (BRCD-Q), a maker of switches for data centres, have more than halved since early June.
The broader S&P Communications Equipment Index has lost 10 percent in the same period.
Yes, analysts say, the heady growth may be over but the industry will keep growing -- driven by the increasing popularity of both smartphones and cloud computing.
Rather than trimming budgets, some telecoms carriers are actually spending more to upgrade their networks to 4G LTE technology and meet the insatiable thirst for data from smartphones and tablets such as Apple Inc.'s (APPL-Q) iPad.
Smartphone penetration in the United States is expected to triple in 5 years from around 20 percent currently, according to a report from brokerage Oppenheimer and Co.
"We don't believe the market will decline and, in spite of the fears of a slowdown, the market will grow, albeit slowly," said Rohit Mehra, an analyst at IT research firm IDC.
He predicts growth will be in the mid-single digits, while Morningstar analyst Grady Burkett expects the overall market to grow at 7-8 percent in the next 2-3 years.
Burkett said the current second half would be weak, but "then we'll probably see a decent snap back in the second-half of 2012 based on easier comps and replacement cycles."
AT&T (T-N) has said it will raise its 2011 capital spending to $20 billion from $19 billion, mainly to support increasing demand for its wireless services. Verizon, which accelerated domestic wireless spending in the first half year, is maintaining its $16.5 billion capex budget for the year.
"We expect the LTE revenue flow to vendors will accelerate significantly in 2012. But it won't be a flood," said Matt Walker, principal telecom analyst at Ovum Research. "With the more incremental LTE upgrades, vendors should see a larger share of capex hit their books."
Ovum expects carrier-service related sales to grow at 11.5 percent, while Morningstar's Burkett predicts routers and switches will grow at 5-6 percent.
"Cisco is still our best idea, and Juniper looks attractively valued ... if you're patient, Juniper is the place to be," Burkett added.
Cisco recently forecast its revenue would rise 1-4 percent this quarter, indicating government and business demand for networking may not be as bad as forecast.
Data centers, the other big customers for gear makers, are also set to boom as companies shift to cloud computing to save on IT infrastructure costs.
Networking gear for data centers -- the giant warehouses lined wall-to-wall with powerful storage servers -- had global sales of about $37 billion last year. Those are forecast to grow to $41 billion in 2012, says industry research firm Gartner.
More companies are putting their servers and data storage together, and this will create more opportunities for gear makers in the next 3-5 years, IDC's Mehra said.
He expects WAN optimizers, which are needed for speeding up traffic over networks, and application delivery controllers (ADCs), which filter data streams, to see double-digit sales growth.
"In ADC, the leader is F5 Networks (FFIV-Q). They will benefit. In WAN optimization, it's Riverbed and they'll continue to benefit," said Mehra.
Aruba Networks (ARUN-Q) is another company making WAN accelerators and optimizers that speed up the flow of data and help filter those data streams in data centers.
Morningstar's Burkett expects WAN optimizers and ADCs to grow in the upper mid-teens.
Analysts also expect Brocade, which accounts for about 70 percent of storage equipment sales, to see revenue growth in the mid-single digit range starting in 2012.
"The fundamentals of networking and the huge need for data management are still very much in place," said Petr Jirovsky, another IDC analyst.