I came down pretty hard on networking veteran Extreme Networks
The main rebuttal
The biggest reason I felt compelled to rate Extreme Networks "underperform" in our CAPS system was this: The company is specializing in the increasingly outdated Ethernet technology at a time when wireless and optical networking are all the rage, and lacks the scale to stand up to its much larger rivals. Therefore, the company should eventually be forced to shut down after a methodical pounding by Cisco Systems
To this attack, Rodriguez countered that Extreme Networks has picked a niche, as outmoded as it may seem, and now focuses on nothing but winning within that limited market. And his company does have something special to offer in the Ethernet space: low cost of ownership and a rich feature set make Extreme a compelling alternative to solutions from Cisco or Brocade Communications Systems
Based on these strengths, Extreme Networks gleefully announced that virtual computing leader VMware
Picking decent role models
OK, so Extreme Networks is for real. In fact, this strategy of extreme specialization is a variation on the tactics that made Netflix
Ethernet is a legacy technology rather than the new hotness, but there's plenty of market available for Extreme Networks if everybody else is leaving. Fair enough.
The margin story
Then I pushed my interview subjects to explain what's going on with the profit margins. In the last earnings call, much was made of a big deal signed in South Korea by out-pricing the competition. Net and operating margins are fragile. It's not a pretty picture.
The Korean deal, I'm told, was a loss-leader effort designed to raise awareness of Extreme's products and services in a strategically important market. "South Korea is a big economy," explained Rodriguez, "but it's a small area, not a lot of people there. If you land a few high-profile contracts in an environment like that, you can get a halo effect that spreads quickly across that market."
I still don't know whether Extreme sat down with a major player like LG or Samsung in this case, but the thinking makes sense and even more so if one of those regional giants were involved. Back out that one deal and last quarter actually saw some of the strongest gross margins in Extreme's history.
Where do you go from here?
Oscar Rodriguez is an industry veteran but new to this job, and he does have his work cut out for him with a recent history of declining margins on the operating and net levels. The competition threat is for real, though Extreme may be better equipped to handle it than I first thought. And the lack of extreme scale shouldn't matter as long as the company sticks to its professed single-market strategy.
I'm removing my thumbs-down on Extreme Networks for these reasons, though I'm not sufficiently reformed to turn the thumb up. I'll watch Extreme Networks like a hawk over the next few quarters to see how Rodriguez plays the hand he was dealt, and you can do the same by adding the company to your Foolish watchlist.
Fool contributor Anders Bylund holds no position in any of the companies discussed here. VMware is a Motley Fool Rule Breakers choice. Netflix is a Motley Fool Stock Advisor recommendation. The Fool has written calls (Bull Call Spread) on Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.