The trend for Internet usage remains clear: up and to the right.
Look at these statistics.
- There are 2.1 billion Internet users around the world, which is only 30% of the world's population.
- Cisco predicts there will be 15 billion Internet devices in 2015 -- twice the population.
- Global data consumption will increase fourfold to nearly 1 zettabyte by 2015.
I had to look up a zettabyte? It's a 1 with 21 zeros behind it. If I stacked enough $100 bills to ... forget it. It's a big number!
Houston, we have a problem
With more people using more data, can the Internet, in its current form, push that much traffic around the world or will it come to a screeching halt? As you will see below, network owner/operators know they have to find a way to scale up their networks while reducing their costs. That's a difficult problem to solve -- and according to venture capitalist Peter Thiel, a huge opportunity.
To hit home runs with start-ups, his Founders Fund looks for companies that:
- Go after big problems.
- Develop transformational technologies.
- Have management teams with "the vision and the flexibility to create a success."
Founders Fund investments include social networking giant Facebook, digital music provider Spotify, and robot designer RoboteX.
Infinera (Nasdaq: INFN ) is well past the start-up phase but fits perfectly within Thiel's framework. Here's why I am buying shares for the Trends and Trades portfolio. Click here to follow all the action on Twitter.
The challenge
Stuart Elby, the vice president of technology at Verizon (NYSE: VZ ) , recently outlined the challenges his company faces given the growth of Internet usage. According to Elby, "The network is becoming too complex and costly." And in order to meet the future demands, Verizo! n is loo king for a "dramatic change in [the] long-term cost structure" of its network -- on the order of 30%-50% less. But at the same time, Verizon needs to deliver faster performance to its customers. It wants speeds of 100 gigabits/second to 400 gigabits/second.
Significantly higher performance and dramatically lower costs are diametrically opposed. But that's the challenge telecommunication companies confront. Users want data today and more tomorrow, without paying higher prices for it. Take streaming video, for example. Together, Netflix (Nasdaq: NFLX ) and YouTube account for more than 38.9% of aggregate Internet traffic. Streaming is the wave of the future and Netflix et al continue to invest heavily to meet the growing demand. In fact, experts predict video will grow to 61% of all Internet traffic by 2015.
In 2000, Infinera looked forward and saw Internet coming to a point where networks would have problems scaling up to meet demand. The company then spent its whole life developing a solution.
The better mousetrap
Infinera caught a big break as the Internet bubble burst. The company developed its breakthrough technology, the photonic integrated circuit, at a time when capital for technology companies had dried up. Like its electrical counterpart, the PIC takes discrete pieces of the network and puts them on a chip. In addition, the PIC performs optical-to-electrical-to-optical transformations cost-effectively, allowing data to move from point A to point B as quickly as possible.
As the Internet bubble deflated, big network equipment suppliers such as Ciena (Nasdaq: CIEN ) and Alcatel-Lucent (NYSE: ALU ) experienced declining sales. Rightly, they started conserving cash, which included cutting back on R&D budgets. But Infinera found smart backers with deep pockets and lots of patience. I! nfinera rewarded those investors by creating the first commercially viable PIC, at a time when no one else could take a chance on developing a transformational technology.
The PIC delivers the innovation Verizon and other big network operators need to scale up their networks: lower investments and operating costs, smaller space requirements, and lower power consumption. At the same time, the PIC delivers higher transport speeds. Infinera's 10 gigabit/sec product (10G) was a huge success, capturing almost 50% market share from 2004 to 2007. But tier 1 telecommunication companies like Verizon need more capability. That's why Infinera will launch its 100 gigabit/sec PIC (100G) in 2012. Its transformational technology will help Verizon and others generate higher performance with lower costs.
The right management team
Going from 10G to 100G was not in management's original plan. But the market threw Infinera a curveball, skipping over the 40G product and demanding 100G. Infinera has had to invest $155 million over the last 12 months to meet the market's new demands and reduce its revenue forecasts. With higher than expected costs and lower than anticipated revenue, the stock market did not take the news very well, sending the stock price lower.
Management deserves considerable credit for sticking to its vision and yet being flexible to handle the new demands from the market. That's not an easy thing to do. Netflix began life as a DVD reseller, not a DVD rental company. Success came after management changed course midstream. Intel (Nasdaq: INTC ) followed a similar pattern, switching from a memory manufacturer to microprocessor producer.
The path to success is never straightforward. The right management team can be the difference between a huge success and a colossal failure, as Netflix and Intel show. I think Infinera's management team has been making all the right moves -- and the payoff is just around the corner.
Infinera went after a big problem: scaling network to meet increased traffic. It developed a transformational technology, the photonic integrated circuit, and set itself apart from the crowd. Management adjusted to the changing demands of the market, developing its 100G product much earlier than expected.
Infinera's technology is about to become very valuable. Exactly how valuable is difficult to predict precisely. But that's OK. Let's get a sense of just how much it could be.
Market-research firm Infonetics expects the 100G market to be about $3 billion in 2014. If Infinera can capture 40% of that share and hit its previous goal of 15% operating margins, the stock could be a five-bagger in three years. Success is not guaranteed, however. If the 100G product launch is a disaster or a competitor comes out with a significantly better offering, the stock could easily get cut in half. I think the latter is very unlikely. After all, Infinera is the only company with a commercially available photonic integrated circuit, a true game-changing technology that helps companies scale up their networks in an efficient, effective manner. That puts the odds of success squarely in Infinera's favor, which is why I will be purchasing a 5% allocation for my Trends and Trades portfolio. Click here to follow along on Twitter and see all of my future purchases.
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