Webscale Network Operators: 3Q19 Market Review

Webscale Network Operators: 3Q19 Market Review
Webscale capex stages a mild recovery with 1% YoY growth in 3Q19, while R&D outlays remain robust
By Arun Menon and Matt Walker

“After successive slumps in capex during the first two quarters of 2019, global webscale operators loosened their purse strings somewhat in 3Q19. Capex spend grew slightly by 1% YoY in 3Q19 – a modest recovery considering declines of 18% and 11% during 1Q19 and 2Q19, respectively. The marginal respite in the latest quarter, however, wasn’t enough to lift capex growth on an annualized and YTD (9 months) basis, which posted a 0.9% and 9.3% decline, respectively, for the period ending 3Q19.

By contrast, R&D investments continued their robust growth journey as most of the “Top 8” webscale network operators (WNOs) continue to invest heavily in R&D projects across a wide spectrum – from self-developed AI-based chips customized for their datacenters and more grandiose moonshot projects such as driverless vehicles.

Long-term growth story still intact

Webscale networks are centered around immense, “hyperscale” data centers and undersea cable systems that support network traffic from the tech companies’ online retail, video, and social media platforms, along with cloud services. Webscale operators may also own access networks, typically using fiber, microwave or mmWave, and even fixed satellite. WNOs exploring outer space for providing connectivity include Amazon, Facebook, Alphabet, and Microsoft. Apple is the latest entrant (reportedly) to the group of operators pursuing satellite technology for internet connectivity.

A broad set of vendors are benefiting from WNO capex, from semiconductor players selling into the data center market (Intel, Nvidia, Broadcom, etc), to optical components & transport vendors selling into data center interconnect markets (Ciena, Infinera, Neophotonics, Lumentum, etc.), to contract manufacturers of white box/OCP servers such as Wistron and Quanta. Despite tightened capex spending in the recent quarters, the long-term growth story for the webscale sector looks intact. Top line revenue growth in the sector was 11% during the first nine months (YTD19), emulating the average annual rate of 10.6% during 2011-18 period. This is expected to continue as WNOs continue to pursue aggressive organic and inorganic expansion.

Geopolitical and slowdown risks keep operators guessing for now

2018 was the year of a spending explosion by WNOs with annualized capex surpassing $100B for the first time in 2Q18, and ending the year at $113.1B. Since then, the going has been tougher for WNO suppliers as the sector invested just $105.3B in the twelve-month ending 3Q19, down by 0.9% YoY compared to high double-digit growth rate in the previous year. The stall in capex spend meant the sector’s cash & short-term investments swell by 10.1% YoY during the same period. However, when looked from a single quarter perspective, 3Q19 provided a small ray of hope for WNO suppliers with capex rebounding slightly to post 1% growth YoY. Free cash flow margins also witnessed a strong uptick YoY in 3Q19 on an annualized basis.

A sub-group of important WNOs, the “Top 8”, continues to be important for tracking the sector. This group includes Alibaba, Alphabet, Amazon, Apple, Baidu, Facebook, Microsoft, and Tencent. Four of these accounted for at least 10% of total WNO capex in the YTD19 period (1-3Q19)- all based in the US: Alphabet, Amazon, Facebook, and Microsoft. Just two out of the Top 8 WNOs, Amazon and Facebook, spent more on capex in YTD19 than previous year. Likely reasons for most webscale operators being cautious on the spending front this year so far may have to do with geopolitical uncertainties such as US-China trade war escalation that is affecting the likes of Apple, along with economic slowdown concerns in China that have impacted the domestic trio of Alibaba, Baidu, and Tencent.

Some WNOs such as Facebook and Alphabet have annualized capital intensities in the 16-25% range, similar to the biggest telecommunications network operators (TNOs). This level of spending will continue at Facebook as they look to continue scaling their network infrastructure and address privacy/security concerns, although it could moderate for Alphabet (Google). While we will see a capex pause in the coming quarters, over the 2-5 year timeframe the outlook remains good for continued investment growth in this sector, focused on data centers and international connectivity.

As has been the trend historically, webscale operators continued spending more on R&D than capex;  annualized R&D/revenues were 10.6% in 3Q19, ahead of the capex/revenues ratio of 7.5%. Webscale operators are plowing R&D funds into a broad range of tech projects, in both predictable areas like artificial intelligence and IoT, and less obvious areas like healthcare (Amazon and Google), food delivery (Alibaba), and connected cars/self-driving (Baidu). Many webscale operators are designing their own chips now, in potential competition with current suppliers; our “Webscale Playbook” series details these efforts.

Webscale operators continue to branch into new markets, including hardware, both through R&D and acquisitions. M&A activity in the sector remained vigorous in 2018, with Alphabet, Amazon, Microsoft, Oracle, and Salesforce each recording sizable related costs. The M&A climate remains strong for the sector in 2020 given its high cash reserves – case in point, IBM’s $34B acquisition of Red Hat. Webscale operators are beginning to more actively partner with telcos on network projects, with Microsoft leading the way with recent big wins at AT&T and Jio in India. IBM, already a big supplier in the telco segment, will use its Red Hat acquisition to further these aspirations.

Total debt for the sector is manageable overall, at $436.9B in September 2019 (cash & STI: $631.1B). Some individual companies could face debt issues in an economic downturn, however, or due to regulatory pressure. Facebook is clearly one of these. More stringent regulations from new political leadership in Washington DC could have a significant impact on several WNOs; this is an issue to watch as 2020 progresses.”

MTN Consulting’s 3Q19 WNO Market Review analyzes the network infrastructure spending and financial position of webscale network operators (WNOs).

WNOs are web-centric companies who own and operate large multi-country communications networks based upon hyperscale data centers and submarine cables. Webscale operators may also own access networks, typically using fixed satellite or fiber. WNOs own network assets in order to support their core businesses, which comprise digital advertising, online retail, cloud, digital media and content services, and other digital-based services. The webscale segment excludes companies with digital business models who rely primarily on rented cloud capacity or collocation space. Twitter, for instance, is not a webscale operator, as its network relies on a mix of rented space in carrier-neutral data centers and rented cloud resources from Google.

WNOs tracked in this report include the “Top 8” companies (Alibaba, Alphabet, Amazon, Apple, Baidu, Facebook, Microsoft, and Tencent) and 12 others: Altaba, ChinaCache, Cognizant, eBay, Fujitsu, HPE, IBM, JD.COM, LinkedIn, Oracle, SAP, and Yandex.

Coverage:

  • Global coverage with company-level drilldowns of 20 companies
  • Company-level annualized and quarterly trends across >10 financial data series
  • Network-related spending estimates at market- and company-level, across quarters

More details are available in the “sample file,” above

Table Of Contents

  1. Abstract
  2. Analysis
  3. WNO Market: Key Stats thru 3Q19
  4. Top 8 WNOs
  5. All WNOs: Company Drilldowns
  6. Totals by Company
  7. About

Figures & Charts

  1. Key Metrics: Growth rates YTD19/YTD18 vs. 2011-18
  2. WNO Revenues: Single-quarter (US$M)
  3. Top 8 WNOs: YoY revenue growth in 3Q19
  4. Annualized profitability: WNOs
  5. Free cash flow per employee, 3Q19 annualized (US$)
  6. FCF Margins vs. Net Margins, 3Q19 annualized
  7. Advertising revenues as % total (FY2018)
  8. Annualized capex and R&D spending: WNOs (% revenues)
  9. WNO capex by type, Annualized: 3Q15-3Q19 (US$M)
  10. Network & IT capex as share of revenues, 3Q19 annualized
  11. R&D expenses as % revenues, Top 8 WNOs (2Q19 annualized)
  12. Net PP&E per employee (US$M) – 3Q19
  13. Ranking the Cloud’s Webscale Network Operators: 3Q19 revenues (US$B)
  14. Ranking the Cloud’s Webscale Network Operators: 3Q19 R&D expenses (US$B)
  15. Ranking the Cloud’s Webscale Network Operators: 3Q19 total capex (US$B)
  16. Network, IT & software capex (US$B) by WNO, 3Q19
  17. 1H profitability trends, WNO Market
  18. WNOs: R&D spending, and network/IT capex, 1H
  19. Network & IT capex as % of revenues
  20. WNO Network, IT and software capex: YoY growth
  21. Total employees: Webscale network operators
  22. Webscale market: Revenues & FCF per employee (US$K)
  23. Revenues & Spending (US$M)
  24. Webscale Business Mix by Revenues (FY2018) – MTN Consulting estimates
  25. Top 10 recent acquisitions & investments
  26. Revenues & YoY revenue growth: by company
  27. Annualized profitability: by company
  28. Annualized capex and capital intensity: by company
  29. Annualized capex and R&D spending as % of revenues: by company
  30. Share of WNO network & IT capex, Annualized: by company
  31. Total employees: by company
  32. Annualized per-employee metrics (US$000s): by company
  33. Net debt (debt minus cash & stock) (US$M): by company
  34. Profitability and cash flow, 2011-18 (% revenues): Webscale operators
  35. Free cash flow and cash on hand, 2011-18: WNOs (US$M)
  36. Revenues & capital intensity, 2011-18: WNOs
  37. Capex and R&D spending, 2011-18: WNO segment (US$M)
  38. Cash on hand, capex and acquisition costs, 2011-18: Webscale operators
  39. Capex and R&D as a % of revenues, 2011-18: WNOs
  40. Capex and leasing expenses as a percent of revenues, 2011-18: WNOs

Visuals

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