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Activity surrounding Open RAN is hitting a fever pitch. We have been seeing accelerating operator and vendor announcements supporting Open RAN, and now the Open Networking Foundation has announced that it is launching SD-RAN to complement Open RAN. The plan for SD RAN is to open up critical portions of the RAN architecture, allowing both open source and vendor based microservices, called xApps, software connect to the SD RAN architecture’s Radio Ixxx Controller (RIC). To date, we’ve seen vendors like Parallel Wireless, Mavenir, Altiostar, Samsung and Nokia throw their weight behind Open RAN. Japanese operator Rakuten has been very vocal about its successful commercial launch in April 2020 that uses Open RAN and a virtual computing system to support various RAN functions such as baseband. ONF’s SD RAN project takes things another step, though, by allowing operators and vendors to to leverage open source in the RAN environment. Getting there presents a challenge. With its announcement, the ONF will support a nRT-RIC and xApps, this is the intelligence that needs to be opened up, according to Timon Sloane, VP for ecosystems and marketing for the ONF based in Menlo Park. He says that functionality from a powerful RIC and xApps can finally deliver the integration and benefits needed for an open approach to work. Adding some muscle, the open RAN development community, and associated carriers globally, have shown their support for this latest project, a software defined RAN that will put a focus on open systems for 5G and the deeper integration. The ONF’s SD-RAN project specifically is backed by a coterie of industry players: The O-RAN Alliance, Telecom Infrastructure Project (TIP), and Facebook. Also, global carriers and cloud providers like AT&T, Google, China Mobile, China Unicom, DT and NTT. Lastly, system/chip companies like Intel, Sercomm and Radisys. The ONF’s proposed µONOS-RIC, is a microservices SDN controller based on ONF’s ONOS platform. 650 Group is bullish on this effort as previous attempts have not come to fruition and the ONF has already had lots of success with its CORD/cloud edge data centers and broadband access with the likes of AT&T DT and Comcast. 
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Like many companies that sell campus networking gear, Ubiquiti Networks saw a slowdown in 2Q20. Its Enterprise-related revenues grew only 4% Y/Y and were down 16% Q/Q. We reviewed the public material from its disclosures this morning, plus as we do during each of the quarters, we are making checks along the way because we assess Ubiquiti’s market share in many of its markets like Ethernet Switching, Enterprise WLAN, Consumer WLAN, routing and security.
The company experienced production delays in the quarter, primarily as a result of its main manufacturing site being located in southern China. It has established subcontract manufacturing relationships recently where parts are made in Vietnam and Taiwan. The company has been penalized with tariffs because many of its products are made in China, so it has an incentive to get out of the PRC. Its facility lease in China ends in a year, and we expect that Ubiquiti will begin using subcontract manufacturing outside of China increasingly. Inventory and purchase obligations are at a record high. At the end of 1Q20, inventories had dropped, probably because of shutdowns in China, but inventories grew nearly 40% Q/Q in 2Q20. We believe that the company is expecting revenue growth in the future, based on its high inventory and purchase obligations. The company attributes its growth to the expansion of distribution channels and expansion of its product line. Since the pandemic shutdowns hit, it appears that the company has not grown its distributor count appreciably. In previous quarters, it had grown its reseller and distributor counts, fueling growth. Coincident with the company’s supply chain difficulties, we have noticed that the company is having trouble getting important new products to volume. For instance, its Amplifi Alien 802.11ax product, while introduced months ago, is unavailable for purchase. We have evidence that some volume was available during 2Q20, though. We see this type of difficulty getting products to volume as related to the sequential growth challenges the company experienced. But, the company has record purchase obligations, so we think it is just a matter of time before it has 802.11ax consumer – and enterprise-class – WLAN products in the market. Our hunch is that by 2H20, the company will have 802.11ax enterprise WLAN products in the market. Speaking of WLAN, since Ubiquiti is selling primarily 802.11ac products at a time when the market is moving towards the newer generation 802.11ax, this is effectively shrinking Ubiquiti’s addressable market as about 1/3rd of enterprise Access Point revenue is related to 802.11ax. Additionally, the company has significant exposure to smaller customers, which are being hurt more during the shutdowns than larger ones. Ubiquiti has been a share-taker in the enterprise WLAN market for many years. But, with the short-term challenges it is experiencing (supply chain, distribution, older product portfolio, customer exposure), its share-taking ended in 2Q20. It looks like the company is taking steps to address the supply chain and product refreshes. However, its exposure to smaller customers and its challenges in expanding distribution are more difficult to fix during the pandemic. AWS (Amazon Web Services) grew nearly 30% Y/Y, remarkable results for a $10B a quarter business. 650 Group enterprise interviews indicate that IaaS is the preferred platform for new application development in the new-normal COVID-19 world. We do expect at some point enterprises will move some of these workloads back to the premise, but don’t expect a headwind. Still, more of normalization as this premises-based move in 2021 will be occurring right as AI workloads add a new leg of growth to IaaS providers. AWS Custom ASIC and semi-custom ASIC development include many projects beyond Annapurna’s Smart NIC and Amazon’s investment into satellite connectivity with a $10B investment in project Kuiper for low earth satellites in direct competition with SpaceX’s Starlink will make the company's Cloud platform even more popular. Also, if satellite connectivity is just for media, which we see as unlikely, the way consumers connect their devices over the next decade is going to go through a significant transformation, and this is just the best-case will have a minimal impact.  Apple’s Cloud business remains locked between business models. Apple monetizes the Cloud portion via hardware sales with little direct revenue coming from Cloud services. While Apple announced a significant networking advancement with Nokia’s new data center switches, a substantial step in the right direction, we have yet to see a significant increase in organic data center spend. Instead, Apple utilized other large IaaS providers for a lot of Apple’s features, which, to a certain extent, we see a conflicted to Apple’s vertical integration of the company's portfolio. We expect Apple’s organic data center spending to increase significantly over the next few years as the company further vertically integrates and competes directly with Google/Facebook on features and capabilities even though the three companies monetize them differently. For example, computing is just as critical in Augmented Reality and Virtual Reality as the handset itself.  The only negative in Microsoft’s earnings in 2Q20 was Bing, expected based on consumer behavior trends. Azure continues to grow robustly as the company experiences supply constraints, just like everyone else in 2Q20. Over the next 4-6 quarters, we expect Project Jedi, the DoD’s Cloud project awarded in 2019 to Microsoft, to ramp up, which will be a significant positive to demand during the quarters in which it recognizes revenue. Microsoft is not only benefiting from enterprises using Azure for application development but also in collaboration with Teams and Office 365. Almost all WFH scenarios help Microsoft, except for higher unemployment (less total office workers). Microsoft remains the dominant #2 IaaS provider and is increasing its influence in the supply chain on future projects and deployments. In 3Q20, we expect LinkedIn revenue to moderate based on fewer companies hiring. We also expect the new XBox, Series X, to be a key driver for Microsoft’s Cloud services.  Facebook revenue grew robustly in 2Q20, and its CAPEX guidance remained consistent for 2020 compared to previous revisions in the last two quarterly results. Facebook’s results were counter trend to our expectations that many advertisers would pull back spending do to COVID-19 based on lack of supply (no need to advertise consumer staples) or from consumer spending put on pause (cars that people don’t need while sheltering at home). We believe Facebook benefited from more time on the platform and from the targeting of specific adds on areas of discretionary spending that did grow like sports equipment (good luck finding a bike, kayak, or other social distancing sports gear) and WFH (consumers shifting patterns of spending more for their residents while WFH or just making the home more comfortable due to extended hours in it). Facebook, like Google, is under government scrutiny for its scale and size. We are closely monitoring the trends of government oversight from the US government and well as other countries like Australia which is forcing Facebook to pay for news as well as Microsoft’s potential purchase of Tik Tok (as of writing this over the weekend, they were still pursuing them). It seems like the duopoly here is not preferred by most governments at this stage and expect election results to polarize the losing party against social media companies into 2021.  Google, the largest US Hyperscaler by revenue, reported Search and Social results that declined Y/Y for the first time while IaaS revenue grew nearly $1B Y/Y. We were a little surprised at Facebook’s robust growth compared to Google’s. Google’s results were in line with our overall expectations for Search and Social decline in 2020 as consumers and advertisers resetting to the new normal. We expect more targeted ads throughout 2020 as consumers live and work from home, and many students live and study from home during the fall semester.
Google has made big bets and investments in IaaS, and we continue to see AI as an area where they will attack AWS and Azure. It is unclear if IaaS is compatible with the culture withing Google, which could put an upper limit on the verticals and companies Google can sell to. During 1H20, Google was surpassed by Amazon in our supply chain interviews as the company with the most influence on the technological direction of industry-wide future products. We see a passing of the guard as AWS CAPEX is now much higher than Google’s, and the supply chain sees Amazon as more significant revenue potential. We expect this change to reverberate throughout the supply chain, primarily based on how each Cloud provider uses custom or semi-custom semiconductors in their data center infrastructure. This is something we are happy to talk about as we prepare our 2Q20 results and our fall readouts. -- Alan Weckel, Founding Analyst, 650 Group Over the next five days, we will highlight each of the US Hyperscalers and the results they had during 1H20 and 2Q20. Today we will start with the overall trends in the market. US Hyperscaler revenue grew 20% in 2Q20 compared to a year ago, setting a new record. US trade war activities, mainly against Huawei, caused significant lead time increases in many critical components for Cloud data center build-outs during the quarter as the 5G battle against China is having ripple effects into the Cloud supply chain. Custom ASIC and semi-custom ASIC development in the Cloud continue to expand with multiple new initiates around #AI #ML., #SmartNICs, accelerators, and #CPUs underway. This is not to mention Amazon Web Services (AWS) getting into #6G with a $10B investment in project #Kuiper for low earth satellites in direct competition with @SpaceX Starlink. There are over 50 custom ASIC projects in the Cloud. Each one has implications on the supply chain and immediate potential to shift market share from each Cloud provider. Our overall projections for data center spend in switching, servers, and storage remain relatively unchanged since our previous forecast. Current results affirm our forecasts as we shift to vendor performance over the next two weeks, which we expect to be dependent on each company’s vertical and enterprise exposure.  |
CHRIS DePUY
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