Mr. Cisco Meet Mr. Avici

By Hal Plotkin Silicon Valley Correspondent

Apr 27, 2001 03:20 PM

You probably already know that the economic downturn has been blamed for most of the problems that have depressed the stocks of leading networking equipment suppliers such as Cisco Systems Inc. {CSCO} and Juniper Networks Inc. {JNPR}.

What you may not know, though, is that the big suppliers are also facing an incursion into one of their key markets by relatively tiny Avici Systems Inc. {AVCI}, a firm that is gaining ground by offering a competing router product aimed at carrier customers that has the classic advantage of doing more for less.

Most of the financial analysts tracking the stock see Avici as a winner going forward. All told, six of the seven financial analysts following the company rate the stock a “buy” or “strong buy.” But there are at least a handful of other experts who warn of the risks associated with the company’s heavy dependence on a limited number of customers and the requirements imposed by its unique technology.

Avici Systems 52-week stock performance

Last week, Avici bucked the tide among optical equipment makers by posting slightly better than expected results for its first quarter ended March 31. Revenues for the quarter came in at $15.7 million, up from $504,000 for the same period last year. The company’s losses came in at 24 cents a share, a penny less than the 25 cent loss analysts had forecast. Avici went public on July 28, 2000 with shares priced at $31 a share.

The revenue numbers for the last quarter are tiny, especially when compared to Cisco’s $18.9 billion in sales last year. But Avici Systems’ CEO Surya Panditi says last quarter’s numbers provide evidence to support his contention that Avici will slowly but surely cannibalize the carrier market targeted by the larger, better-known suppliers. (Carriers are large telecom firms).

“We don’t comment on our market share goals,” he says. “But we expect to grow faster than the market and achieve market share growth because we have a product that allows that to happen.”

The worldwide market for core routers is forecast to grow to $12.7 billion in 2003 from $4.5 billion this year, according to RHK, a telecom market analysis firm based in San Francisco. Much of that growth is driven by projected increases of up to one thousand percent per year in Internet backbone traffic, which in turn drives sales of Avici’s core product, which is called the TSR scalable core router.

The company’s backers and its detractors alike agree that Avici’s patented technology offers a measurable technical advantage to large telecom customers. The company’s box, which is usually placed in telecom central offices, accepts a greater number of telecom feeds, or inputs, than competing devices using roughly the same amount of space. More important, telcos can more easily increase the number of lines handled on an as-needed basis without paying for the addition of any unused carrying capacity.

“We have a scalability advantage,” says Panditi. “We can add more density to the network while using less power. Customers are very focused these days on finding the best solutions, including finding ways to reduce power [consumption].”

Avici’s detractors, however, say the company’s success does not come without problems. While sales were reasonably strong last quarter on a relative basis, the majority of them, over 85 percent, came from just three companies, Enron Corp. {ENE}, Qwest Communications International {Q}, and American Telephone and Telegraph Company {T}. What’s worse, Enron recently announced that it will be reducing capital expenditures to $250 million from the $750 million originally planned for this year. There are also conflicting views about whether Avici’s non-standard size box fits easily in the racks and cages found in most telco central offices.

“It’s not a central office compliant box,” says Sam Wilson, an analyst with the Merrill Lynch Technology Group, based in San Francisco. “People are willing to bend the rules a little on things like that, but I think it’s a handicap.”

Wilson has a “neutral” rating on the stock, adding that he’s also worried about what could happen if any one of the company’s three main customers has a sudden change of heart.

“My concern isn’t this year,” he says. “It’s the expectations for next year.” Not knowing what is going to happen with those major accounts, he says, injects too much uncertainty into the stock.

“We’re selling to the larger carriers,” counters Panditi. “So by nature there’s going to be a small set of customers.”

The flipside of that, though, according to Panditi, is greater visibility than can usually be found elsewhere.

“When you only have a few customers you can work very closely with them to do a higher level of custom development, and to provide better customer service,” he says. The close relationships also provide Panditi with better insight than most vendors into customer buying decisions and plans.

On Enron, for example, Panditi says he’s already been assured the company’s announced spending cutback won’t affect its purchases from Avici.

“The Enron cutback is not going to come out of our hide,” he says. “That’s something we already know.”

The bigger threat down the line, though, is what might happen if and when companies such as Cisco or Juniper change their product architectures to better compete with Avici’s current scalability advantage.

But that would be no small feat in that previous technologies are based on what is called a “centralized switch matrix,” while Avici’s is built around a decentralized, or “distributed fabric.”

“Building a distributed switch, which we have done, is radically different from what they [Cisco and Juniper] have done,” contends Panditi. “I have a very healthy respect for Cisco and Juniper as competitors, but there are architectural issues that will make it very hard for them to build scalable router.”

“Basically, what Avici has done is increase the number of ports per square foot, which is a measure of how much money one of their customers can make,” says Wilson, of Merrill Lynch. “But I do have concerns about whether theirs will be the best solution over time, or whether others will emerge.”

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