Network Equipment Makers: You've Been Cleared for Takeoff

Since the recession, it's been difficult for technology companies to put together the full package.

In some cases, such as data analytics provider Splunk, growth has been phenomenal but profits have remained elusive as all cash flow from operations has been reinvested in research and development and in hiring new staff. In the case of Splunk, second-quarter revenue rose 50%, but the company isn't expected to deliver its first quarterly profit until well into 2014.

On the flip side, other tech companies have been bringing in cash flow by the boatload, but have needed to turn to cost-cutting to drive bottom-line growth. Hewlett-Packard, for example, is in the midst of a massive transformation which involves laying off about 8% of its workforce -- 29,000 employees -- in order to save $3.5 billion annually. The company is still very profitable but is being heavily weighed down by its underperforming PC segment.

The good news is that one tech industry looks like it's been cleared to put both pieces of the puzzle together: network equipment makers.

It all starts with communication service providers

Source: lllythr, Wikimedia Commons.

For network equipment makers, it all starts with communication service spending. Following the rollout of 4G networks in the middle of the last decade, the great recession put a big crimp in service providers' plans to upgrade their networks to 4G LTE. With consumer spending weak, many of the biggest names -- AT&T, Verizon, Sprint, and T-Mobile -- chose to stay the course until there was more clarity within the sector. Apparently things must have improved in a hurry in over the past year, because businesswide consolidation cleared the way for a big boost in infrastructure spending.

AT&T started it off in November when it announced that it would be spending $14 billion over the next three years to greatly expand its wireless infrastructure, with the goal being to catch Verizon, which has more than doubled the number of cities that are 4G LTE-capable relative to AT&T. Following AT&T's announcement, in 2013 we saw Japan's SoftBank scoop up a majority stake in Sprint for $21.6 billion, giving the struggling service provider some much-needed capital to expand in 4G LTE network, and T-Mobile gobbling up MetroPCS Communications in order to instantly gain 9 million new customers.

The clarity you seek lies with fiber-optic and fiber-optic component suppliers
By now you're probably wondering, "How do we know this increase in spending is trickling down to equipment makers? The answer to this question is written entirely in fiber-optic and fiber-optic component suppliers, which have seen a revival of sorts this year. When telecom service companies announce a big boost in spending, it often takes a few quarters for that money to trickle down to fiber-optic providers. Have a look at some of these big EPS hikes in just the past three months.


Projected Full-Year EPS 3 Months Ago

Current FY EPS Projections




Alliance Fiber Optic



Oplink Communications



Source: Yahoo! Finance.

Finisar, a fiber-optic components supplier, just last night reported record first-quarter revenue which handily exceeded the company's own previous estimates, and guided its second-quarter revenue and EPS well above the existing forecast. Similarly, Alliance Fiber Optic, a small-cap fiber-optic components maker, reported a whopping 248% increase in net income in the second quarter, as revenue rose 65%, and also guided its third-quarter results slightly ahead of already boosted Wall Street estimates.

How you can take advantage
The tech upgrade cycle when it comes to wireless infrastructure is pretty straightforward. First, wireless providers announce the race to deploy new networks, then fiber-optic and fiber-optic component suppliers benefit, and then finally, networking equipment makers, such as data and networking optimization join the party not long after. With that mind in, here are a few companies that could be next in line to see big gains that you would be wise to have high on your watchlist:

Source: CiscoSP360, Flickr.

Cisco Systems
Simply put, when big data is being moved around, Cisco should be one of the first names investors turn to. With a huge focus on big data center servers and switches, AT&T, Sprint, and T-Mobile's plans to spend heavily on trying to catch Verizon in 4G LTE capability should have clued investors into Cisco as a potential beneficiary. Cisco's recent earnings results certainly haven't given shareholders anything to write home about, but its steady cash flow and cost-cutting tactics via layoffs should result in a surprisingly profitable 2014 that I believe will catch Wall Street off guard.

Juniper Networks
Cisco's little brother, Juniper Networks delivered impressive second-quarter results in July despite the muted reaction by investors to the retirement of CEO Kevin Johnson. Juniper was not only able to deliver a 7% increase in revenue over the previous year and guide its third-quarter projections slightly ahead of the Street, but it also commented that it was seeing "early signs of improving security demand." That right there is Juniper's hint that it expects orders to begin streaming in perhaps as early as the second half of this year.

F5 Networks
In addition to hardware, you should also have your eyes on companies like F5 Networks, which is an application delivery network technology specialist. In English, that just means it provides traffic management on servers and optimizes data routing. Newer wireless networks are capable of delivering more information at faster speeds which will strain existing delivery technology if it isn't improved at the same time as the wireless infrastructure upgrades. I believe the fears over reduced government spending for F5's network-based applications will prove overdone and F5 will surprise investors in 2014.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool recommends Cisco Systems and F5 Networks. The Motley Fool owns shares of F5 Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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