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Webscale Network Operators: 2Q20 Market Review

Shrugging off COVID-19 concerns, the webscale sector witnessed yet another strong quarter in 2Q20 aided by continued investments in network infrastructure. Single-quarter revenue growth inched past the pre-COVID levels (14.3% in 4Q19) to post 15.1% in 2Q20 year-on-year (YoY). However, growth is still lower than the peak levels of +18% recorded during 3Q17-3Q18 period. On an annualized basis, the sector’s top-line grew by 13.5% YoY in 2Q20.
The network spending of big webscalers is centered around immense, “hyperscale” data centers and undersea cable systems that support network traffic from the tech companies' online retail, video, and social media platforms, along with cloud services. Webscale network operators (WNOs) may also own access networks, typically using fiber, microwave or mmWave, and even fixed satellite. WNOs exploring outer space for providing connectivity include Amazon, Apple, Alphabet, Facebook, and Microsoft. Out of these, Amazon’s efforts gained fruition recently with the FCC approval for its satellite broadband initiative, Project Kuiper, to deploy and operate a constellation of 3,200+ low earth orbit (LEO) satellites. Satellite investments from non-webscale players such as SpaceX (Starlink) is heightening the webscale activity.
A broad set of vendors are benefiting from WNO capex spending – from semiconductor players selling into the data center market (Intel, AMD, Nvidia, Broadcom, etc), to optical components & transport vendors selling into data center interconnect markets (Ciena, Infinera, Neophotonics, Lumentum, etc.), to contract manufacturers of white box/OCP servers (Wistron and Quanta).
Infrastructure upgrades continue to drive capex, while R&D growth experiences a slowdown  
Capex spend saw a sequential surge of more than 20%, posting 20.4% YoY growth in 2Q20 (25% YoY growth in 1Q20). A portion of this strong growth in the first two quarters could also be attributed to a lower base in the corresponding quarters of the prior year, considering falloffs in three out of four quarters in 2019, which included double-digit declines of 17.5% and 11.4% during 1Q19 and 2Q19, respectively. But that doesn’t take away much from the efforts of the operators who continued to add more servers and networking related equipment in their data centers to keep up with the demand of remote access to cloud-based tools and services. New data center construction, though, did not contribute much to capex growth in the first half of the year. The strong uptick in the latest quarter also aided in capex growth on an annualized basis, posting an overall increase of 9% in 2Q20. Annualized capex reached an all-time high in 2Q20, hitting $114.4 billion; the previous high was $113.1B in 4Q18. One positive was the increased spending by China-based WNOs such as Alibaba and Tencent, who are caught in the midst of the US-China trade headwinds and restrictions. Both these operators have pledged to invest billions of dollars in next-generation mega data centers, semiconductors, servers, and related technologies. Some of those investments reflected in the latest quarter, boosting single quarter capex for China-based WNOs by 88% YoY in 2Q20.
Growth in R&D investments, though, slowed down to post 12.3% YoY growth in 2Q20 (vs. 15.1% in 1Q20), and unlike capex growth, it failed to track near pre-COVID levels (18.6% YoY growth in 4Q19). On an annualized basis, these investments clocked 16.0% YoY growth to post $164.8B for the 12 months ended June 2020. This is important because overall, WNOs spend more on R&D than capex – as a percentage of revenues, annualized R&D/revenues were 10.7% in 2Q20 vs. 7.4% annualized capex/revenues. Despite this, the long-term growth story for the webscale sector looks intact. The sector's cash & short-term investments growth also remained steady throughout the COVID crisis, logging 10.8% YoY growth in 2Q20, the same growth rate as 1Q20.
Spending and investment trends by key operators
A sub-group of important WNOs, the “Top 8”, continues to be important for tracking the sector. This group includes Alibaba, Alphabet, Amazon, Apple, Baidu, Facebook, Microsoft, and Tencent. Four of these accounted for at least 10% of total WNO capex in the twelve-month period ending June 2020 – all based in the US: Alphabet, Amazon, Facebook, and Microsoft. Half of the Top 8 WNOs – Alphabet, Apple, Facebook, and Baidu – spent less on capex in 2Q20 than in 2Q19. For ecommerce-based WNOs such as Amazon (109% YoY growth in capex), Alibaba (102%), and JD.com (87%), capex growth has been a reaction to the COVID-19 situation – their spending focused on fulfillment centers and supporting technology, but also targeted cloud operations, for Amazon and Alibaba in particular. Capex-related developments for select WNOs are summarized below:
  • Alibaba: announced plans for US$28B of investments over several years for building data centers, chips, and servers
  • Alphabet/Google: the company plans to ‘recalibrate’ data center spend and freeze hiring new staff due to COVID-19
  • Microsoft: expects "healthy" capex in 3Q20 to meet the surge in demand across its cloud-based tools and platforms
  • Facebook: halted two data center projects (Alabama in United States, and Ireland) in March 2020 due to the coronavirus pandemic. Data center construction in New Albany halted in August 2020. US$800M data center coming up in Gallatin, Tennessee
  • Tencent: announced plans for US$70B spending over the next five years to build new data centers and infrastructure to boost its cloud computing capabilities
With respect to R&D spending, webscale operators continued spending more on R&D than capex;  annualized R&D/revenues were 10.7% in 2Q20, ahead of the capex/revenues ratio of 7.4%. Webscale operators are plowing R&D funds into a broad range of tech projects, in both predictable areas like artificial intelligence and IoT, and less obvious areas like healthcare (Amazon and Google), food delivery (Alibaba), and connected cars/self-driving (Baidu). Many webscale operators are designing their own chips now, in potential competition with current suppliers; our "Webscale Playbook" series details these efforts.
M&A activity in the sector posted a strong performance in the twelve-months ending 2Q20, with Alphabet, Amazon, Microsoft, and HPE each recording sizable MA costs. However, IBM's $34B acquisition of Red Hat stole the show during the twelve-month period. Webscale operators are also beginning to more actively partner with telcos on network projects, with Facebook's $5.7B splash on a stake purchase in Jio Platforms. Microsoft is also leading the way with recent big wins at AT&T and Jio in India. IBM, already a big supplier in the telco segment, will use its Red Hat acquisition to further these aspirations.
Going forward, spending growth will be tested by demand volatility and supply chain constraints
The current pandemic situation has somewhat proved to be a silver lining for large WNOs with strong and sizeable cloud businesses and offerings, as lockdown measures across major economies have resulted in a spike of remote access to cloud-based tools and services. However, they are also faced with two key obstacles:
  • Slowdown in enterprise spending: New enterprise customers are hard to come by, given the spending cutbacks amid the pandemic situation. Amazon’s CFO, Brian Olsavsky, already acknowledged this during the recent analyst call when asked about AWS’ slowing growth.
  • Supply chain headwinds: With COVID cases continuing to rise in major economies, lack of high-technology components for network infrastructure along with delayed shipments have caused disruption to the supply chains worldwide.
From the operators’ point of view, WNOs with significant dependence on 'non-cloud' businesses and relatively smaller players will likely restrict their spend on webscale buildouts/data centers in 2H20 – as seen with Apple and Facebook. They must prepare to counter the effects of supply chain and workforce disruptions until the pandemic subsides considerably. While both the quarters in the first half of the year saw capex growth surging above 20% YoY, overall, it is unlikely to sustain into the rest of the year and is expected to be in the 8-15% range.
MTN Consulting’s 2Q20 WNO Market Review analyzes the network infrastructure spending and financial position of webscale network operators (WNOs).
WNOs are web-centric companies who own and operate large multi-country communications networks based upon hyperscale data centers and submarine cables. Webscale operators may also own access networks, typically using fixed satellite or fiber. WNOs own network assets in order to support their core businesses, which comprise digital advertising, online retail, cloud, digital media and content services, and other digital-based services. The webscale segment excludes companies with digital business models who rely primarily on rented cloud capacity or collocation space. Twitter, for instance, is not a webscale operator, as its network relies on a mix of rented space in carrier-neutral data centers and rented cloud resources from Google. By contrast, Apple is webscale; although it has partnerships with GCP and AWS for cloud capacity, Apple owns several large data centers, and is building more.
WNOs tracked in this report include the “Top 8” companies (Alibaba, Alphabet, Amazon, Apple, Baidu, Facebook, Microsoft, and Tencent) and 12 others: Altaba, ChinaCache, Cognizant, eBay, Fujitsu, HPE, IBM, JD.COM, LinkedIn, Oracle, SAP, and Yandex.
  • Global coverage with company-level drilldowns of 20 companies
  • Company-level annualized and quarterly trends across >10 financial data series
  • Network-related spending estimates at market- and company-level, across quarters
  • Revenues broken out by region for each company
More details are available in the “sample file,” above
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Matt Walker
Chief Analyst