Xconomist of the Week: Andy Ory on the Real Opportunity for Acme Packet

Acme Packet is not the easiest technology company to write about. If you’re not careful, you end up bogging down in things like SIP trunking, IMS deployments, session delivery solutions, and other Internet Protocol networking lingo.

Fortunately, Acme Packet’s co-founder and CEO, Andy Ory, makes things easy. Ory has led the Bedford, MA-based company (NASDAQ: APKT) from the beginning, and he’s seen a lot of things over his 12 years there—and at his previous company, Priority Call Management, which he sold in 1999. As he explains, his company’s big opportunity has to do with providing secure and efficient communications and data networking in the Internet cloud. This impacts everyone from big companies to telecom operators to social Web firms, but it also affects consumers, who are using all sorts of different devices and networks to communicate in their daily lives.

“If you make a phone call, it’s quite possible your voice is passing through an Acme Packet product to help set up the call and maintain quality,” says Ory, an Xconomist.

Yet things have not been easy for Acme Packet as of late. While the company’s revenues grew to $307 million last year, with close to $80 million in profits, the company’s stock price has fallen from around $70 last spring to less than $30 now—and its market cap from $5 billion to $1.8 billion.

If Ory’s worried, he’s not showing it. Acme Packet, which went public in 2006, has always been about long-term growth, and that hasn’t changed. Besides, the company has shown it can take a punch and come back strong. Back in 2008, in the midst of the recession, Acme’s stock fell below $4 before rebounding strongly over the next few years. The current market volatility and increasing complexity in IP networks, however, makes it really important for Acme Packet to continue elucidating its value proposition.

Acme Packet makes session border controllers, which is technology to help telecom network operators and enterprises manage voice-over-IP and other Internet services in a secure, efficient, and regulation-compliant way. What’s more, the company could play a big role in several fast-evolving tech arenas: helping wireless carriers compete with the likes of Apple and Google for control of mobile apps; unifying video communications like Skype and Apple’s FaceTime; and providing security and compliance for big businesses’ cloud-based systems. In short, Acme Packet could help redefine what “phone” companies and “software” companies actually do.

Here’s Ory’s snapshot of where the company stands today: “We have between 750 and 800 people. We crossed the billion-dollar mark for products shipped in terms of revenue. We have 16,000 products deployed in 107 countries. We added 300 or so customers last year. And I think we’ll actually pass $100 million of aggregate revenues with two different customers of ours, showing the capacity for what large service providers can buy,” he says. “We’re single-digits [percentage] of the way into this opportunity.”

I sat down with Ory earlier this month at Harvard University (his alma mater), where he was leading a meeting for analysts, press, and potential partners. Here is an edited transcript of our conversation:

Xconomy: Can I get your thoughts on the ups and downs of Acme Packet’s stock?

Andy Ory: When people value an enterprise they look at its operational characteristics, and they project that same operational characteristic onto future opportunities, and then they can extrapolate a value. You can be simple and say, “Some of the very rapid growth has slowed down somewhat.” Though if you look at our bookings growth rate over the last five years, it’s been on average 28 percent. Between 25 and 30 percent is probably the way to think about our past and future opportunity. What people are wrestling with right now is how to understand the opportunity. It’s the magnitude, the imperative, and our market positioning. These are the three things people are coming to grips with. And as they do, I think you’re going to see the enterprise value fall in line with the opportunity.

X: How big is that opportunity, really?

AO: People think that voice services aren’t worth much. If you took gaming, social, and search, and tied all that revenue together, it comes to about $70 billion last year. It was about a trillion dollars in voice services. It’s not even close. What people are paying for isn’t really voice—what they’re paying for is security, quality of service, regulatory compliance. Voice is definitely going away as a stand-alone service. But we’re interactive beings by nature. The way we deal with our friends, family, and customers, is going to be interactive, it’s not just over e-mail or text. So the notion of providing a unified communication that’s secure, has high quality, you can trust— that’s going to require the technology we make.

It impacts every business, it impacts every homeowner, and it impacts everyone carrying a phone. That’s really hard for people to come to grips with. The real question is, can Acme Packet maintain or grow our market share? All last year, our service provider market share stayed the same, at around 57 percent. So I think 50 to 60 percent is the right kind of market share we ought to have. The next closest didn’t even have a fifth of our market share. So we think we’re in the right position at the right time.

X: Talk about the company’s performance over the past year, and how you see its growth going this year.

AO: You always want it to go as high and fast as you can go. I was pleased with last year. I think the thing I wasn’t pleased with last year is the business predictability. The 33 percent revenue growth came at the expense of building backlog; it came at the expense of visibility. We specifically provided guidance this year that was really designed around growing the business. We want to create cash, we want to be profitable, that’s really important to us. At the same time we don’t want to under-invest, and we want to build backlog. I think we can accomplish all those objectives this year. You know, it’s a journey. It’s not a Q1 issue, it’s a 2012 journey.

X: So what are the big areas of investment for Acme Packet?

AO: There are two horses in the barn. There’s mobile, and there’s enterprise. When I say mobile, the whole world is going wireless—you have to solve the mobile issue, your LTE [4G data network] issue for services. Once you do, you’re going to extrapolate that solution over all of your different networks and subscribers. That’s why mobile or LTE is a watershed event. It’s a product that’s much more Web-like. It’s abstracted from the actual hardware, and it can be deployed as all software in data centers. It can dynamically expand and contract the amount of capacity, and it is the way that service providers, like the AT&Ts and Verizons of the world, are going to be able to compete with the over-the-top players [like Apple, Google, Yahoo, Facebook]. We’re really, really high on that.

The other thing we’re excited about is enterprise. We think that the enterprise market clearly is moving all-IP. Everyone’s bringing their own devices to work now, and they’re all untrusted. They’re all running their own applications, and the IT managers are sitting there saying, my gosh, how am I going to unify my services so they can work with every device and provide security? That’s what session border controllers do for IP connectivity.

So, 41 of the Fortune 100 are starting to use our technology. We really feel like we’re moving in the right direction. We’ve talked recently about our relationships with Hewlett-Packard and Microsoft. Distribution is really important for Acme Packet. It’s one of the more strategic aspects of us moving forward. We don’t need—though would like it—everyone distributing us into the enterprise. We just need someone distributing us into every enterprise. Once we get in, people can look at our technology as a tool they can start to use for other issues as well.

X: How do you see the carriers vs. Web software companies playing out?

AO: There are three states. One state is a pure over-the-top service where you use your access network purely for connectivity. The best example there is Apple TV. I still pay for programming from my [cable company], but I’m probably watching 85 percent of my content through Apple. Another state is when you pick up your black telephone at home and you use Verizon or AT&T. The third state is where they partner together. I think you’re going to see that happen.

There are some companies like Telefonica, which purchased JaJah [in 2009]. Both Telefonica and Jajah are customers of Acme’s. Jajah was an over the top company. Telefonica bought them and made them the centerpiece of Telefonica Digital. When you go to Telefonica Digital and you sit and talk with these guys, they look at you and say, “We are not a phone company. We see 300 million subscribers on Mother Telefonica’s global networks, and we’re going after them.” They say, “Once we do that, we’re then going after everyone else’s subscribers.” It’s kind of cool.

More likely than not, I think the innovation is going to occur over the top. You’re going to have people in dorms in Cambridge and Palo Alto and elsewhere that are going to come up with really interesting ideas, but they’re going to want differentiated service, and to make sure there’s high quality or security or regulatory compliance. They’re going to say to the network companies that can provide the connection, the Verizons or AT&Ts, “I’d like to buy a special circuit. I’d like to partner with you on the value that we create.” You saw it at Mobile World Congress: both Google and Facebook are starting to talk to the carriers about differentiated access.

X: And how do you avoid getting caught in the middle?

AO: People say, “FaceTime for video—that doesn’t use you guys, doesn’t that work against you?” I say no, no, no, you’re missing the point. It’s like a flip of the magnetic field. Things aren’t going from professional and networks to personal use, it’s the other way around. Seeing people in an unregulated, best-efforts, free way innovate is sort of the testing ground for the stuff that’s going to be hardened, secured, and then offered to businesses and homeowners. So I actually think it’s like a feedback loop. If you look at the early best-effort, over-the-top innovations, those are precursors for the kinds of things our service providers and enterprises can participate in using our technology to enable.

X: Ultimately, what will the carriers—some of your biggest customers—bring to the game?

AO: Apple sold 25 billion apps in 5 years. Every one of those apps rides over the top of the carriers’ networks. Every single one. They’re using the carrier’s data network that’s not service enabled. When the carriers service-enable their network, they can participate in the next generation of apps. That’s what our technology lets them do. That’s a big deal.

If you’re on Skype and I’m on FaceTime, it doesn’t work. Skype doesn’t want to spend time or money making it work, and Apple doesn’t want to spend time or money making it work. But what carriers do is they provide interoperability, they provide service reach. When you’re an AT&T subscriber, they’re not saying, “You want to use us because we can reach more phones than Verizon can.” You just expect you can reach everybody.

Right now [carriers] are marketing something that, built into it, is security, trust, quality of service, regulatory compliance, availability, interoperability and so forth, but you think you’re paying for voice. What they need to do is decouple the actual application from the attributes they can provide with applications and services. They should make those attributes available as building blocks that people can put into their applications. And then I think they’ll have a very interesting construct for value.

Gregory T. Huang is Xconomy's Editor in Chief. E-mail him at gthuang [at] xconomy.com. Follow @gthuang

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