Consolidation in the Air?

Baird Says Deal Activity in the Cloud Networking Sector May Not Happen As Quickly as Thought

October 19, 2015

With the recently announced Dell /EMC deal, there’s been much discussion of a pending wave of consolidation in the sector. However, we believe such activity may not happen as quickly as many expect.

Certainly, consolidation is in the air. Legacy networking companies are looking to defend their competitive positions against a wave of next generation disruptors. Their traditional hardware-based computing, storage and networking solutions are moving to a software-defined infrastructure, which converges these multiple data center functionalities under a single virtual solution.

While legacy leaders certainly are looking to acquisitions to remain relevant, the opportunity to buy the emerging market leaders remains unclear. There are a lot of very well-funded “next gen” players that have had their sights set on an IPO; not selling out.

We are still in the early innings of the transformation underway in the traditional data center. Many of the most exciting players have dreams of being the game changer in their sector. It will still take a few years following their IPO before anyone can confirm their place in history as a true disruptor.

The more likely opportunity for the legacy players is a younger set of emerging companies that likely need another 18-24 months to scale until they are IPO ready. This group may find the public markets are unable to accommodate all candidates, especially those that are the second or third competitor in a particular sub-category.

Does this mean that this second wave of disruptors will prove to be more fruitful hunting ground for the legacy leaders looking to build up their networking creds in a software-defined, virtual, cloud-based world? The question is how long does it take for the Bid / Ask spread to converge, given the relatively early innings of the transformation underway.

Many of these companies have raised tremendous amounts of capital at hefty valuations. Several are “Unicorns,” many times over. The problem this poses is that investors underwrote their investments assuming multi-billion-dollar exit valuations, in many cases through an IPO. These investors are typically blue chip funds that are unlikely to be forced to take the option of quick liquidity for a business with strong fundamentals and promise.

.The near term implication then may be that legacy players feel teaming up to compete against the market disruptors is the best way to stay relevant. Over time however, consolidation will indeed occur, as many of the next gen players will find there is not enough room in the public markets for everyone. Many of these companies will grow into an acceptable exit valuation and, not surprisingly, some will not be as wildly successful as they hoped.

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