Enterprise technology heads for the clouds in search for growth; VMware paid $1.3 billion for Nicira with revenue of $5m

June 3, 2013 2:48 pm

Enterprise technology heads for the clouds in search for growth

By Richard Waters in San Francisco

When it comes to the sky-high prices being paid for the hottest new companies in business IT, there have been few starker examples than Nicira. A specialist in a field known as software-defined networking, the Californian start-up was sold to the much larger VMware last year for nearly $1.3bn.

Yet at the time, two people familiar with its finances now say, it had generated lifetime revenues of only about $5m.

Such deals barely raise an eyebrow on the consumer internet. But they represent something new in the more staid world of so-called enterprise technology: a hunger for growth at the expense of profits, and a race for strategic advantage amid a secular change in the IT landscape.The soaring valuations are a product of what has come to be known as the cloud – the combination of a massive centralisation of computing power and proliferation of low-cost mobile devices. Together, they are transforming the so-called “stack” of technologies on which complex IT systems are built, as businesses seek to capture greater efficiencies of scale and make workers more productive with mobile access.

“The entire stack is being rewritten to enable cloud infrastructures,” said Asheem Chandna, a venture capitalist and director of Palo Alto Networks and Imperva, two companies that recently rode the initial public offering wave that has followed.

“You never get fired for buying from IBM” has been the slogan of generations of IT purchasing managers. That conservative mindset is bending, however, as new technologies such as the one championed by Nicira break through.

With investors captivated by the growth potential, the 23 software companies that have floated over the past two years have produced an average return for their investors of 61 per cent, according to Ted Tobiason, a managing director at Deutsche Bank.

“The market has said, we don’t care as long as you’re growing,” said Peter Fenton, a partner in Benchmark Capital – though he warned: “You have to ask, how long does the patience of public investors last?”

The impact of the cloud on enterprise technology is being felt in two main ways. The main components of IT systems – storage, networking and processing – along with the management and security software needed to run and secure the new clouds, are being transformed.

That has created a need for new technologies that can handle far higher volumes at much lower costs, said Peter Levine, a partner at venture capital firm Andreessen Horowitz – a disruptive moment that opens the door to start-ups, which were locked out by established players in a more stable market.

The next companies to go public on the back of this could include names such as FireEye, a security concern, and Good Technology, which manages and secures fleets of mobile devices. Both have already filed to go public under the provisions of last year’s Jobs Act, which allows companies to file confidentially, according to a person familiar with the situation.

The second beneficiaries of the shift to the cloud are so-called software-as-a-service companies that supply the applications that ride on top of the new infrastructure. Oracle and SAP, the leaders in business applications, have been forced into a spate of acquisitions over the past year as they race to keep pace.

The next wave of upcoming companies in this field have more in common with the consumer internet than just their high valuations and profitless growth. Many have also adopted a consumer-led business approach to get around conservative corporate IT departments and appeal directly to users.

“It’s the 21st century business model for enterprise technology,” said Christian Chabot, chief executive officer of Tableau, a data analytics company that went public earlier last month.

Such companies try to make it easy for workers to access and start using their services by using free introductory offers or by enabling simple credit card payment. They also copy the more intuitive and accessible design style of consumer internet companies to appeal to a broader range of workers than have previously used business software applications.

“They’ve been hyper-growth but not sales-heavy,” says Mr Fenton, an investor in companies such as Zendesk, which sells customer support software, and New Relic, whose technology is used to manage applications.

Zendesk reached its first 10,000 customers with a self-service model before it hired any sales people, said Mikkel Svane, its chief executive.

“You can start this organic, viral fan base around a product,” he said. “We have dramatically expanded the market,” he added, with half of the company’s customers new to business applications like this.

Both the new cloud infrastructure and applications, however, present a common challenge to the IT market: they embody deflationary forces that hit directly at the business models of the established companies.

The software produced by Nicira, for instance, is intended to separate the management of computer networking resources from the actual routers and switches on which networks rely – a process that promises to greatly raise the capacity utilisation of hardware and reduce the number of machines customers need to buy. A similar process of “virtualisation” in servers has already hit that market hard.

The “freemium” model used by the new software-as-a-service players also threatens to undermine the high per-seat licensing fees of older companies.

To optimists in the tech world, however, this is nothing new. Every previous new generation of computing architecture has led to big price declines but also a massive expansion in the market, said Mr Levine. According to such views, the overall pie will get bigger – even as the slices enjoyed by some of the incumbents shrink.

The latest wave of enterprise IT investors, hooked on growth, will certainly hope that theory still applies.

 

July 25, 2012 10:46 pm

Nicira deal extends VMware’s cloud vision

By Paul Taylor

VMware’s $1.3bn cash and stock purchase of Nicira Networks, a five-year-old software company, signals the opening of a new front in the move towards data centre virtualisation and cloud computing that could deliver additional benefits to the company’s big corporate customers.

The deal, announced earlier this week, will accelerate VMWare’s own cloud momentum reaching from the desktop to applications and the data centre and now – with Nicira – into the network by delivering a new layer of software that sits on top of the physical network infrastructure.

VMware which has already established a dominant position in the market for virtualising servers in data centres, is betting that Nicira, backed by Andreessen Horowitz and Lightspeed Venture Partners among others, will enable it to add virtualised networks to its product portfolio and ultimately deliver what it calls ‘the software defined data centre’ – one that can expand or contract as needed.

Nicira software, which has already won the endorsement of customers including AT&T, eBay, NTTand Rackspace, enables users or the ‘tenants’ of a software defined data centre to, “assemble their own virtual data centre with an isolated collection of all the resources they are used to … it’s the architecture for the cloud,” said Steve Herrod, VMware’s chief technology officer in a Computerworld blog post.

“Nicira will help us advance our software-defined networking activities,” he added.

Like other forms of virtualisation, the key benefits to corporate users are speed of deployment and flexibility. “Nicira allows us to repurpose network infrastructure on demand and reduces the time it takes us to deliver a service from days to minutes,” says Jean-Christophe (JC) Martin, Cloud Architect at eBay in an endorsement on Nicia’s website.

Underscoring the point, Julian Box, chief executive of Calligo, another customer, notes, “Nicira makes it possible for us to pool our computing resources, including networks, as one big pool of capacity, which radically simplifies our operations and reduces costs.”

Another key advantage of the acquisition for VMware identified by analysts including those at technology Business Research, is that it should increase VMWare’s involvement in the open source community.

Nicira’s founders invented OpenFlow, a networking protocol for software defined networks. “VMware’s open-source credibility remains nascent, and Nicira’s executives can deliver significant visibility to VMware’s open-source assets – particularly with Nicira’s ongoing involvement with OpenStack and the Open Networking Forum,” said Elizabeth Hedstrom Henlin, TBR’s enterprise software analyst.

“With technologists at Nicira’s helm and both companies sharing roots in Stanford research projects – signalling a likely culture fit – along with VMware’s broadening go-to-market approach (inclusive of cloud and virtualisation), TBR believes VMware is well-positioned to integrate and monetise the acquisition of Nicira by the end of 2012,” she added.

However other analysts noted that the acquisition could push VMware into more direct competition with Cisco which, like other major network equipment companies, has been pushing into the nascent network virtualisation market with its own technology.

June 3, 2013 2:48 pm

SaaS groups enjoy heady valuations

By Richard Waters

Jam tomorrow, rather than jam today. That is the promise of the software-as-a-service companies that now boast some of the headiest share prices in the enterprise technology world.

Workday and Splunk, both of which listed their shares last year, along with Netsuite, whose stock has risen 93 per cent in the past 12 months, trade at between 16 and 24 times their forecast 2013 revenue. Even the more established Salesforce.com, the pioneer among SaaS companies, sells for 6.4 times revenue.

The combined stock market value of these four now totals about $50bn, or 235 times the total after-tax profits they are expected to produce this year.

Defenders of such high valuations argue that the way the companies account for their subscription-based businesses understates their true performance. Since they defer booking sales until the period in which they are earned, SaaS companies lack the high upfront revenues – and profits – an earlier generation of software companies was able to report when signing new contracts.

The greater consistency of their revenues has also come to command a premium. Older software companies relied far more on the sales they could make each quarter rather than an annuity-like stream of subscriptions, according to Peter Levine, a director of a number of start-ups including Github, a fast-growing service where developers store and share their code.

The true earnings power of the SaaS companies will only show through once they move beyond their high growth phase, supporters say: at that point, deferred revenues will shrink as a proportion of the whole and hefty marketing costs, which often eat up 50 per cent of revenue, will fall.

Share prices built on high growth multiples, however, may not react well to such a transition. Flipping the switch from growth to profits could end up being devastating for shareholders as SaaS earnings multiples fall back to earth.