The Cloud is Still Merciless to Enterprise Hardware Firms, But Security is a Strong Point

 | May 08, 2017 | 9:56 PM EDT
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For much of 2016, numbers from industry research firms painted a bleak picture for enterprise IT hardware demand, as cloud adoption and changing spending priorities did a number on corporate purchases of servers, storage, switches and much else. First-quarter earnings reports from the likes of IBM (IBM) , Intel (INTC) and F5 Networks (FFIV)  suggest conditions haven't improved much, at least outside of one particular market.

IBM's Systems unit, which sells servers, storage and server operating system software, saw revenue drop 16.8% annually in Q1 to $1.4 billion, missing a $1.53 billion consensus. Cyclical pressures for IBM's age-old mainframe business were a factor -- the Z Systems mainframe line was last refreshed in early 2015 -- but hardly the only one. Sales also fell for IBM's proprietary Power servers, as growth in Linux workloads (a nascent business) failed to offset UNIX declines. Storage was a strong point, with hardware sales growing 7% due to flash storage demand.

One could point out that IBM's mainframes and Power servers have been losing share for years to servers running Intel Xeon CPUs. But Intel reported its Data Center Group (DCG, server CPU division) saw enterprise sales drop 3% in Q1, after having dropped 3% in 2016. And considering DCG's sales were propped up by a 6% average selling price (ASP) increase, the decline in enterprise unit shipments was likely worse. DCG's total revenue grew 6% to $4.23 billion thanks to strong cloud and telco demand, and a 20%-plus increase in sales of non-CPU products.

F5 missed fiscal fourth-quarter estimates, and also issued below-consensus first-quarter guidance. The company, which has been seeing healthy security product growth and weaker demand in its traditional application delivery controller (ADC) business, blamed EMEA and services revenue pressures.

Mellanox Technologies (MLNX) , a top provider of high-speed server connectivity hardware and chips, also missed estimates and issued light guidance, as weak demand for its mainstay InfiniBand business offset healthy Ethernet demand from cloud clients. The company blamed "seasonal trends" in the high-performance computing (HPC) market, a delayed launch for Intel Xeon CPUs based on the chip giant's Skylake architecture (they're due in mid-summer). There's speculation that products based on Intel's Omni-Path interconnect fabric are taking share from InfiniBand, but Mellanox insists this isn't the case.

Finally, Gigamon (GIMO) , a provider of network monitoring and traffic intelligence hardware, tumbled two weeks ago after providing light Q2 guidance with a Q1 beat. The company blamed softness in the North American enterprise market. Shares more than recovered their losses on Monday after activist Elliott Management disclosed a 15.3% stake, and said it wants to talk to management about launching a "strategic review."

While company-specific factors are clearly impacting many of these companies, it's still hard to ignore the broader trend. Enterprises are spending less on their on-premise IT infrastructures, as they continue migrating workloads to cloud infrastructures and increasingly rely on cloud apps and services for brand-new workloads. And while some firms are able to offset enterprise declines via rising sales to cloud giants such as Amazon, Google and Microsoft, it's a lot harder for others.

IDC estimates global server revenue fell 4.6% in the fourth quarter to $14.6 billion, and external storage system revenue 7.8% to $6.5 billion. Chances are that the firm's Q1 numbers will point to further declines. HP Enterprise (HPE) and Cisco Systems' (CSCO)  January quarter reports, due later in May, should provide more color on the state of IT hardware spend.

Meanwhile, research firms have been generally upbeat about security IT spending, as enterprises and governments continue reacting to well-publicized security breaches by upping their purchases of hardware, software and services meant to protect their networks, endpoints and data. IDC forecast last October that global security spending would see an 8.3% compound annual growth rate (CAGR) from 2016 to 2020, growing to $101.6 billion. Gartner, using a different methodology, forecast security IT spending will rise 7.6% this year to $90 billion, and hit $113 billion by 2020.

And Q1 earnings reports suggest security IT demand is picking up after a recent lull. Check Point Software (CHKP) has surged to new highs since beating Q1 estimates, reporting 13% billings growth and issuing above-consensus full-year guidance on April 27. A 27% increase in software subscription revenue helped, but so did better-than-expected firewall and threat-detection appliance revenue.

Likewise, rival next-gen firewall vendor Fortinet (FTNT)  beat estimates on the back of 22% billings growth, and hiked its full-year billings guidance to a range that implies 18% growth at the midpoint. Notably, the company singled out the North American enterprise market as a strong point (Americas billings rose 27%), and reported a 31% increase in $500,000-plus deals.

Other security firms posting strong numbers include web app firewall and database security software vendor Imperva (IMPV) , e-mail and threat-protection software vendor Proofpoint (PFPT) and -- relative to expectations at least -- beaten-down hardware, software and services provider FireEye (FEYE) . This could bode well for next-gen firewall/subscription services vendor Palo Alto Networks (PANW) , which plunged in February, after soft guidance, and has been seeing tougher competition from Cisco.

And while security tech firms aren't immune to broader on-premise IT spending pressures over the long run, the fact that many of them also provide offerings for protecting apps and data residing on public clouds makes things a little easier. Together with the need that CIOs feel to better protect IT assets regardless of where they're located, and hopefully avoid having their company become the next Target or Anthem, that leaves security IT firms in good position to continue outperforming over at least the near-term.

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