New world order: Network industry financials show shakeup at the top

A financial analysis of the big guns tells a story of change

Netwrork World's annual analysis of financial results from network companies in 2006 focused on 12 industry bellwethers. HP knocked off IBM for the top spot in terms of sales, Dell lost its PC crown to HP, and AT&T was poised to regain the top telecom perch.


Consider the computing sector. HP and IBM have made huge opposing bets in recent years, with HP amassing PC assets and IBM going the opposite direction, divesting its PC business and placing its chips on professional services.

A cool trillionThat's the total market capitalization of these 12 network companies.
CompanyMarket cap
AT&T

$243.3 billion

Cisco

$162.3 billion

Dell

$55.8 billion

HP

$109.7 billion

IBM

$142.7 billion

Juniper

$11.9 billion

Microsoft

$278.8 billion

Nortel

$10.5 billion

Novell

$2.6 billion

Sprint

$59.8 billion

Verizon

$108.9 billion

3Com

$1.7 billion

Total

$1.188 trillion

HP: King of the hill

Last year HP became the largest computer company in terms of revenue, with sales increasing 6% to $91.7 billion compared with IBM's year-end total of $91.4 billion.

HP's Personal Systems Group alone generated $29 billion in sales (32% of total revenue), which is about $10 billion more than IBM's entire systems group. And that doesn't even take into account HP's revenue from larger systems.

HP has had particular success in 2006 with laptop sales, which grew 8.4%. According to IDC, HP's PC sales beat Dell's in the third and fourth quarters of 2006.

The company says it also did well in industry-standard servers, claiming a revenue increase of 6% while not providing the actual dollar amounts.

Corporate expenses, however, are still running high, the company states in its annual report, limiting profits to $6.2 billion, less than a 7% return. In response, HP says it has streamlined operations by removing three layers of management and is looking to optimize a number of areas, "from real estate to procurement to IT to supply chain."

To address the IT problems -- a bit embarrassing for a company hawking IT answers -- HP is consolidating 85 data centers worldwide to 12 centers built using standardized configurations of HP equipment.

The company's $4.5 billion acquisition of Mercury Interactive last year -- the largest deal since the merger with Compaq -- should also help on the profit side. Although HP's software segment represents 1% of total revenue, the Mercury acquisition is central to HP's plan to position the company as the key supplier of tools to optimize IT operations (never mind that it hasn't done a good job of that internally).

IBM: Betting on service revenue

Software, of course, is one of IBM's key sources of profits. Software sales increased 8% last year to $18.2 billion and generated 40% of IBM's pretax income, according to the company's annual report. That helped IBM deliver a whopping $9.5 billion in total profits, 53% more than HP and second only to Microsoft in this analysis.

But sales for Big Blue were essentially flat in 2006 compared with 2005, increasing less than 1% to $91.4 billion. That's because the '05 revenue numbers include four months of IBM's PC business, which the company divested in April of that year. If you delete the PC numbers from the '05 results IBM would have realized a 4% revenue gain in 2006.

That's nothing to sneeze at but not stellar growth either, and part of the blame lies squarely in the lap of IBM's vaunted service business.


The financial heartbeat -- a slideshow

Services account for 53% of revenue, and the segment has been troubled for a few years. IBM's services business grew 2% last year to $48.3 billion, and its contribution to pretax income was 37%, less than the software segment even though services drives more than twice the revenue.

IBM acknowledges the issue, saying service contracts are trending toward "smaller deals of shorter duration, higher profitability and more industry-specific focus. While our transition to this model experienced some hiccups initially, we are making steady progress and saw solid growth in short-term signings in 2006."

In the fourth quarter alone the company signed nearly $18 billion in new service business, which the company says is "our largest since the second quarter of 2002."

Ironically, while the services sector has wobbled, IBM's systems business has been churning ahead, growing 5% last year to $20 billion, largely on the back of strong mainframe sales and new gear, such as blades.

So, was IBM's bold bet worth it? In 2004 IBM generated $5 billion-plus more in sales than it did in 2006, but $2 billion less in profits. The jury shouldn't have a problem with that question.

Dell: The year from hell

The verdict is back on Dell, and heads are rolling.

Revenue growth has stalled, income has dropped, the Securities and Exchange Commission (SEC) is investigating accounting and financial-reporting irregularities, and the executive team has been shuffled.

Not a good year (technically Dell's 2007 year, which ended in February).

Dell managed to nudge up sales 2% to $57 billion, the first time in years the company has posted less than double-digit growth. And things are going from bad to worse: In the fourth quarter, revenue declined by 5% compared with the same quarter a year earlier, the first time Dell has seen revenue slip since 2001.

The income picture is even more disturbing. Dell's 2007 profit of $2.6 billion was the same amount it posted in 2004, despite the fact that sales back then were $16 billion less than in 2007.

To make matters more interesting, the SEC is conducting an investigation into whether the company misstated certain financial reports, which has led the Nasdaq to consider delisting the company's stock, a nearly incomprehensible turnabout for this once high-flying market darling.

In response to all of this, in January Dell booted CEO Kevin Rollins, and founder Michael Dell assumed those duties, promising to return the company to its glory days by shortening product-development cycles and developing new approaches to manufacturing and distribution. He admitted, however, it will be a haul: "We won't achieve our goals overnight, but we will achieve our goals," Dell said.

One interesting development: The company reports that "In the fourth quarter Dell's international unit shipments exceeded U.S. shipments for the first time in company history. This drove the mix of revenue from outside the U.S. to a record 46% of Dell's revenues."

Microsoft: Playing nice with Novell

Microsoft doesn't care who sells the platforms, as long as the sector as a whole is growing. The company's fiscal year ends in July, so to get a more up-to-date sense of how the company is faring, we looked at quarters that more directly map to calendar 2006. That approach shows revenue increasing 11% to $46 billion, but profits slipping 9% to $11.9 billion.

The profit dip isn't surprising, because Microsoft is in the process of pushing out so many new offerings, from Vista to new versions of Office and Exchange.


The financial heartbeat -- a slideshow

Think this stuff is inexpensive to develop? Microsoft spent more on R&D in fiscal 2006 -- $6.6 billion -- than any of the other companies examined here, including IBM, which is more than twice as large.

Over the years, Microsoft has nicely balanced out its portfolio. Today its client segment (the various flavors of Windows) represents 30% of sales, while the server segment (Windows Server, SQL Server, Exchange Server) is 26%, and information worker (Office, Project) represents 27% of sales. Home and entertainment (Xbox and TV-platform products) accounts for 10%.

Perhaps the most momentous announcement for the company in 2006 is the news that Bill Gates will scale back his duties to part time in 2008.

And maybe Microsoft's second-most-surprising announcement of the year was a wide-ranging business and technology partnership with Novell intended to make it easier for companies to run, integrate and manage Linux and Windows in their environments while steering clear of patent and intellectual-property concerns.

As reported in Network World, "As part of the partnership, Microsoft will not assert its patents against individual noncommercial open source developers, nor will it assert its patents against individual contributors to OpenSuSE.org, whose code is included in the Novell SUSE Linux Enterprise platform, including both the server and desktop version.

"In addition, Microsoft said it will recommend SUSE Linux Enterprise for customers who want Windows and Linux products. Microsoft said it will distribute 70,000 coupons for SUSE Linux Enterprise Server maintenance and support, so that customers can benefit from the use of an interoperable version of Linux.

"In terms of interoperability, the two said they would jointly develop a virtualization offering for both Linux and Windows that would allow either to be the host or guest operating system."

Novell: Struggling to halt revenue slide

For all of the Linux hoopla that Novell is generating, Linux still represents a fraction of the company's sales. In the fourth quarter, for example, Linux Platform Products accounted for $13 million of the company's $245 million in total revenue.

Besides Linux, the other key growth area Novell has identified is identity and access management, a segment that generated $24 million in the company's final quarter.

Meanwhile, the company reported that "revenue from Open Enterprise Server and NetWare-related products declined 25% from the year-ago period."

Novell finished 2006 with revenue of $997 million, a decrease of 7% from 2005, and profit of $32 million, compared with $373 million in 2005, but the latter included a $448 million net legal settlement with Microsoft.

Clearly, Novell has its work cut out for it, with large-core segments declining more rapidly than smaller, more promising new categories are growing.

Cisco: Juggernaut rolls on

Network heavyweight Cisco doesn't have to worry about balancing the new against the old. Revenue rocketed up 15% to $28.4 billion in 2006, largely on the back of the $6.9 billion acquisition of Scientific Atlanta, the company it is relying on to get into the video distribution game.

Profits, however, dipped 3% to $5.6 billion in the company's fiscal 2006, which ended July 29, the first slide in recent memory. The company partially blames new regulations that require it to account differently for stock-based compensation expenses.


The financial heartbeat -- a slideshow

Cisco's fiscal year ended last July, and the quarters that landed in calendar 2006 tell an even better picture. Revenue has increased a whopping 23% to $31.8 billion compared with the preceding 12-month period, and profits have increased 14% to $6.4 billion.

Yet Cisco seems rather docile of late, a huge predatory beast that is laying low, still trying to digest its last big prey, Scientific Atlanta, which added 8,000 employees to its ranks.

The biggest news last year was the launch of the company's TelePresence video conferencing effort and the release of Call Manager 5.0, which shifts its IP PBX offering to Session Initiation Protocol and Linux. Otherwise, Cisco seemed content to ride on the coattails of existing products:

* Its core enterprise platform, the Cisco Catalyst 6500, passed $20 billion in sales.

* The company shipped its 8 millionth IP phone.

* Some 60 service providers are said to have adopted the Cisco Carrier Routing System since it was introduced two years ago.

* Enterprise customers have installed more than 3 million of the company's wireless access points.

Cisco did acquire eight companies last year, but all of them were small fry, with fewer than 100 employees, and most of the deals were worth less than $50 million.

Nortel: Back in the black, barely

Nortel would love to have some time to rest on its laurels, but the company has been too busy trying to remake itself after a number of tumultuous years.

How bad has it been? "2006 marks the first year with positive operating cash flow since 1998," the company says in its annual report.

Sales grew in 2005 for the first time in five years, and the company kept up the momentum in 2006, as revenue increased 8% to $11.4 billion. That gain, the company says, was driven primarily by results from LG-Nortel, the joint venture Nortel created in late 2005 with LG Electronics of Korea to sell enterprise and carrier network gear in Asia.

Profits, however, are still hard to come by, as the company barely made it into the black last year, with net income of $28 million.

But under the leadership of CEO Mike Zafirovski, who has been on the job for a year and a half, Nortel is making significant bets. Most notable among them: a four-year strategic alliance with Microsoft to jointly develop, market and sell unified communications products. In other news of note, Nortel got back in the routing game by acquiring Tasman Networks and sold off its Universal Mobile Telecommunications System assets to Alcatel-Lucent for $320 million to focus its cellular efforts on Code Division Multiple Access technology.

Nortel also sees big opportunity in WiMAX, one of three core areas the company is focusing on for growth. The other two are IP Multimedia Subsystem and IPTV.

3Com: The worst may be over

3Com is another troubled network infrastructure player that is beginning to see light at the end of the tunnel.

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