CSCO – VMware buys emerging competitor Nicira for $1.26b
Last night VMware announced it is buying Nicira for $1.05b cash plus $210m earnout.  This is an a significant move for VMware/EMC and the networking space (and for Cisco and Juniper).  Nicira developed the Open flow protocol for software defined networking (SDN) which at its root is server  virtualization for networking gear.  SDN seeks to separate the networking software from the physical hardware.  Much like server virtualization allows more than one server instance to exist on one server – SDN allows for multiple servers on a single network node or to move the servers and networking “location” using software without reprogramming the networking gear each time.  This is an emerging space with several new startups like Nicira and Big Switch as well as investments by Cisco (they invested $105m in Insieme in April*).   The payoff in SDN resides not as much in hardware savings, though there are some, but in the flexibility and speed to deployment.  Nicira has top tier early trial customers in eBay, AT&T, Rackspace and NTT, as has had positive feedback.

The impact for Cisco is twofold:  1) SDN seeks to isolate the intelligence of the network, something Cisco has embedded in the switches and routers it sells at premium prices; 2) VMW and EMC are partners with Cisco in selling data center solutions.

Cisco is already facing several headwinds including weakness on the macro front in Europe, continued lack of public spending, stronger Fx, and ongoing restructurings (additional 1,300 layoffs yesterday).  In addition, the overall market looks to be rolling over.  The sharp sell off in Cisco is mostly related to a fear of competitive pressures that will hurt its core franchise – switches and routers.  The near term impact will be negligible and longer term networking gear will still be required and upgrades… but the risk is Cisco’s premium pricing and margins, as well as partners.  Cisco has proven over time it can adapt, but this bears watching closely both for risks to Cisco, and also overreaction to the news (as may be seen yesterday by the larger downside move in Cisco) – shares should recover.

CSCO 4/20/2012
*has spun off and provided $105M in funding for Insieme, a project to create switches based on software-defined networking (SDN). In an employee memo, Cisco says it retains the right to buy Insieme for up to $750M, and outlines its SDN strategy. Cisco faces a tricky balancing act: it needs to compete with the SDN solutions of upstarts, but has to avoid cannibalizing sales of its high-margin, proprietary gear.