Enterprise equipment vendors often tout big design wins from high-profile customers. Recently, Infinera (NASDAQ: INFN), maker of wave-division multiplexing equipment, issued a press release detailing a big achievement for its new Cloud Xpress 2 (CX2) product for data center interconnections -- a design win with Netflix (NASDAQ: NFLX).
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Netflix buys Infinera
The fact that Netflix chose Cloud Xpress is a huge vote of confidence in Infinera's technology, no doubt. Netflix is the premier video streaming service, with over 100 million subscribers in 190 countries that stream 125 million hours of programming per day. Streaming all that video requires huge amounts of bandwidth -- exactly what Infinera's products enable. Moreover, Netflix promotes itself as an arbiter of good technology, even ranking internet service providers' (ISP) speed with its ISP Speed Index on its website.
The Cloud Xpress 2 has impressive features, such as 1.2 terabyte-per-second speeds up to 130 kilometers. In addition, the new system contains software-defined features that allow Netflix's engineers to scale capacity as needed with very little provisioning. Given Netflix's huge bandwidth needs, the ability to scale up and down quickly is important so that the company does not have to pay for any more capacity than it needs at a given time.
David Tempkin, Netflix's vice president of global networks, said of the CX2; "The Infinera Cloud Xpress 2 makes it easy to deploy new high-capacity links between our Open Connect content delivery points of presence and quickly scale capacity to match demand."
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While winning a big customer such as Netflix is a big deal, don't hit that "buy" button just yet. While having impressive technology is great, it does not, by itself, make for a good investment. In contrast, a highly competitive environment and changing industry landscape is actually putting Infinera in a world of hurt right now.
On the company's third-quarter conference call, Infinera management got real about its current predicament, pointing to a number of headwinds:
- 1. Customer consolidation: this is a problem because as customers become bigger, they have a bigger sway over pricing. In addition, problems with a big end-customer can lead to very lumpy and inconsistent results. That's what's currently happening with CenturyLink and Level 3), which are scaling back their capital spending as the two companies focus on integration.
- 2. Price "aggression": As I previously wrote on a piece regarding Infinera competitor Ciena, the wave-division-multiplexing industry is fiercely competitive, and Infinera is not immune to these pricing pressures.
- 3. Disaggregation: This is a development affecting many traditional enterprise hardware companies. While buyers of switches and WDM systems used to buy entire integrated systems, software-defined networking has allowed customers to buy merchant silicon components from low-cost vendors that -- combined with advanced software and middleware -- can deliver performance near or even with sophisticated integrated systems. That means that Infinera may have to sell all of its components separately in the future or figure out a new pricing model.
In light of these challenges, Infinera is implementing a cost-reduction program, which it believes can take $40 million out of its operating costs. The program will include, "an R&D remote site closure, a rationalization of products and programs, and a reduction in headcount across all functions of the company." CEO Thomas Fallon believes these measures will allow the company to return to profitability in the second half of 2018.
The company lost $37 million in the third quarter alone, so even if the cost-cutting measures had been implemented ($10 million quarterly), the company would still have been unprofitable. In short, there is a lot of work to do here.
Investors in any company need to assess the competitive landscape and industry dynamics, not just a single product. While landing a big customer is great, being overly dependent on a single customer is not.
While having leading technology is great, it only matters if that allows you to sell for a large profit. And while being a leader one day feels good, changing technologies and dynamics can erode that leadership over time.
Infinera obviously has great technology but it is dealing with all of these pressures right now. That's why investors should take a wait-and-see attitude over the next few quarters at least.
In fact, Fallon put it quite succinctly when he said, "I think that the whole industry right now is trying to figure out the appropriate business model for this new paradigm of open."
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Billy Duberstein owns shares of CenturyLink, Level 3 Communications, and Netflix. The Motley Fool owns shares of and recommends Infinera and Netflix. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.