The technological revolution we are experiencing today is not the first technology wave that has occurred since the Industrial Revolution. In fact, the prior tech wave featuring mass production, autos and oil—which took place from 1908 to 1974—saw an almost identical buildout of infrastructure. What propelled the U.S. economy to its enormous heights during the 20^th century was the construction of roads and highways to enable burgeoning interstate commerce.

The National Highway System was conceived in 1926—just a few years prior to the stock market crash of 1929. Similarly, the tech market crash of 2000—which led to the onset of the “Great Recession” a few years later—was presaged through the creation, and buildout, of the Internet in the latter 1990s. What the National Highway System was to our fledgling automobile-based economy in the Roaring Twenties is what the “Information Superhighway” was for the frenetic 1990s dot-com age.

A byproduct of the National Highway System became the very well-known Route 66. Starting outside Chicago, it would eventually stretch all the way to the Pacific Ocean. Nat King Cole famously sang about it as the early auto economy emerged, followed by American families taking their first motoring vacations.

Just as with the Internet today, companies gave away products on Route 66 to spur future sales. Mile-long sections of Route 66 still exist that were originally paved for free to show small towns what a high-quality paved highway could mean for their economies. The try-and-buy products you see every day are done for the same reasons today on the Internet. You download software, and if you like it you can buy and expand the feature set that came with the free download.

The first enterprises that sprang up along Route 66 were small mom-and-pop type of operations. The better ideas were soon co-opted by larger and better capitalized corporations, which would become major forces within the U.S. economy. Companies such as McDonalds, whose first hamburger stand was built just outside of Chicago, grew increasingly larger as they sold ever more franchises along Route 66 as it was built out.

Other companies such as Holiday Inn built their first motor inns on Route 66 (image for the first Holiday Inn on Route 66: http://media-cdn.tripadvisor.com/media/photo-s/05/0f/8b/02/route-66-hotel-and-conference.jpg. It has been argued that the very idea for the motel had been born first on Route 66.

Why do we go to the trouble of describing all this? Because the buildout of the vertical infrastructure in the current information technology wave is moving along a remarkably similar path as in the prior technology wave, and there is a valuable lesson to be learned.  The companies which laid the highway down on Route 66 but did not maintain their growth and revenue streams did not grow in the same way McDonalds, Holiday Inn or the future hotel chains such as Marriott did. Those companies far outpaced those shortsighted road builders from the past and have long since obliterated most of them.

Another important lesson from the previous tech wave: During its peak in the 1950s, when the Eisenhower Highway system was planned and constructed, the increase in Route 66’s quality and size was not large enough for any of those highway construction companies to gain entry into the DJIA or become a Fortune 500 company.  While Route 66 had proven that the concept worked, it was eventually dwarfed by a more robust solution.  

We believe the same revenue spike exists today. The Internet’s creation resulted in tremendous opportunity for Cisco and other networking companies. Cisco, Juniper and the others have had a huge opportunity in building out the Internet. As the Internet is improved in speed and security, how will these companies generate growth on what amounts to replacement technology that will become increasingly commoditized and bring in far less revenue?

The answer is, of course, that some of the networking companies have cracked the code from the past and realized that they must set up shop on the “off ramps” of the Internet to substantially expand their growth. Verizon is the first telecom to have seriously leveraged its Internet roots and created the kind of McDonalds-type fast food chain for the second half of the current technology wave. For others such as Cisco, Juniper, and F5 the jury is still out. Their plans have yet to translate to successful chains for the Information Age.

To be clear, we still see the opportunity for them to do so via innogration strategies. Furthermore, the traditional networking companies still generate tremendous cash flow from improving the Internet and networks worldwide. Therefore, we think that there is money to be made from investments for some of the networking companies. As each of them executes their respective strategies, we will evaluate their performance and make our portfolio recommendations accordingly.

Why Verizon Is Winning

Verizon made the right moves starting when it was one of the seven Regional Bell Operating Companies (RBOCS), also called Baby Bells, created by AT&T’s court-ordered divestiture during the 1980s. Instead of assuming the telecommunications world would always be run on pairs of twisted copper wire, they quickly acquired one of the other Baby Bells (NYNEX) and then merged with GTE. They were also the first to shed their Bell Atlantic name and created the new name Verizon. In short, they quickly reinvented themselves to be able to fully execute their strategy for innogration before anyone else beat them to it.

What Verizon realized at that time was communications was headed for a wireless world and not the wired one which was generating all of its revenue. As the Internet arrived at the same time of their merger with GTE they clearly were betting on a far different future world. In a few short years Verizon would be proven correct, generating more revenue from just ringtone sales for cell phones than from all of their landline telephone operations combined.

Verizon continued on its innogration plan and continued to invest in their cellular business to the point where they began to sell off their landlines. We smile today when we watch the movie You’ve Got Mail and hear the unique pinging sound of Tom Hanks’ modem chugging to connect with the Internet of the latter 1990s. Verizon understood that there was an information superhighway coming and they wanted to not only build it out but set up stores within it.

The Internet quickly spread to satellite and cable provider competition access. Why did Verizon not only survive the intense competition which the convergence of these once separate technologies brought, but thrive? And more importantly, how did they do it?

Verizon has thrived by continuing to invest in their cellular infrastructure. I can recall back in Verizon’s early days visiting a friend’s cabin on Lake Gaston, on the border of Virginia and North Carolina, where he had to borrow my Verizon phone to make a call as his Sprint network would not reach.

Flash forward 15 years later as I was standing in a Verizon store near my home at 7PM to upgrade to the iPhone 5S and the store is full – on a weeknight! This was almost two months after the launch of iPhone 5S. I imagine that is what it was like to pull up in your latest Chevy with long tailfins at a McDonalds in the 1950’s. It was commerce but at the same time was also a cultural event.

Verizon has gained the upper hand in the cellular market with the largest and most redundant cellular network. Let’s not forget that Verizon was winning even before they added the iPhone to their smartphones lineup. After adding the iPhone their network traffic went up from all the customers using Siri for voice searches and surfing the net from their smartphones. But did Verizon’s network fold up like a cheap suit the way AT&T’s had?

No. Verizon’s network did begin to slow so they repurposed an old data network pipe and are regaining the unchallenged crown of the fastest and most reliable network. The reasons are twofold. First, Verizon has set up chain shops on the Internet that they own. Retail stores had been death for most tech companies who dared to step out onto the virtual Route 66.

Verizon has succeeded where others failed because they are innograting instead of buying. Verizon doesn’t own any of the tablets, smartphones and other smartphone accessories they sell. But they get a piece of the revenue the sales of those products generate without having to invest in developing those products.

Verizon also sells Internet access and residential TV packages which are cored in their FIOS technology. Verizon is winning against the cable and satellite companies for Internet and TV on top of their cellular business. Customers spend $300 to $400 a month for Verizon’s bundled services. Verizon is winning by having built out the virtual Route 66 and setting up retail chains on the highway at the same time. This enables Verizon to pay a healthy dividend and be on track for equity growth into the future.

Watching the Networks

In the second tier of STI’s tech 50 are the Internet networking backbone companies. At the top of the second tier is Cisco Systems. Cisco provides networking products for enterprise business customers along with the telecom companies. Fourteen years ago Cisco rode its networking manufacturing success to the top of the dot-com bubble; it had the world’s highest market capitalization in March of 2000.

The dot-bomb collapse along with the rise of other networking competitors has since moved other companies to have higher market capitalizations over Cisco. However, two things must be said about Cisco Systems.

First, they got to the top of the networking gear providers by purchasing smaller networking companies and then integrating them within their product lines. Cisco’s ability to innograte better than the competition leapfrogged the pack. Therefore, Cisco has innogration in its DNA which is the key to success in the tech industry.

Second, just like the National Highway System, the Internet’s backbone is constantly being improved in both speed and security. The Internet has to be improved as the data loads being pulled down the network are growing at exponential rates. The growth of websites, PCs, companies on the Internet and finally devices like smartphones is causing this tsunami of data being transferred around the internet.

The radical growth of Big Data requirements has provided Cisco a steady revenue flow as they continue to deliver and ship newer and ever-faster networking switching products. As an added bonus to its shareholders, Cisco pays an unusually high dividend for a tech company, which demonstrates the strength of its continued cash flow.

However, Cisco has not yet found a way to both build out additional highway for the virtual Route 66 and create a franchise chain like McDonalds or Marriott hotels. Those endpoints are the area of greatest growth for the second half of the current tech wave. Continuing with the analogy from the prior wave, Cisco is competing to be the equivalent of one of the Big Oil companies that fueled the auto tech wave.

Without an entry in the endpoints marketplace, Cisco will have to beat out other large tech companies which are converging competitively for the Big Data and Cloud markets. Can Cisco do it?  Yes they can – but they have not done it yet. However, they are worthy of investment for the next 18 months as we see how Cisco intends to execute their next innogration strategy.  If they get it right, the rewards could be extreme.

Juniper Networks came into existence as the dot-com stocks raged in the late 1990s. Juniper majors in very high performance network products. By 2004 Juniper had taken 30% market share from Cisco for a sub segment of the network market. Juniper has practiced good innogration planning in releasing one of the industry’s best network automation tools in partnership with Puppet Labs in 2012. However, Cisco has fought back and the rate of growth for Juniper has slowed. Since Juniper doesn’t pay a dividend, STI is monitoring them but they are not a recommended buy.

The final telecom we are watching is F5 Networks. Similar to Juniper, F5 was listed on NASDAQ in 1999. F5 has taken a different approach to network acceleration by speeding up applications running on the network. Cisco has exited this network market space so F5’s future opportunity appears bright.

F5 is too young to pay a dividend; however, they have been practicing innogration with key acquisitions such as Swan Labs (2005) and Acopia Networks (2007).  This demonstrates that F5 understands that innogration is the only way to take the competitive networking hill. 

Despite their fast growth, we don’t recommend buying F5 just yet. Given that they are accelerating development of applications for the Cloud, a cohesive innogration strategy is what we are looking for as evidence that they correctly see the end game.  Also, like Cisco and Juniper, they will have to find a way to effectively compete in these converging market segments.

Remember: Even though the previous tech wave made a fortune for investors in McDonalds that recognized the value of being positioned along the off-ramps of the interstate highways, not every fast food restaurant survived. Knowing where to be is only half the battle; knowing what to do when you get there is the other half.  

STI Portfolio Stocks mentioned in this article:

Verizon (NYSE: VZ) is a ‘hold’ in our Smart Tech 50 Portfolio

Cisco Systems (NSDQ: CSCO) is a ‘buy’ up to $24 in our Investments Portfolio

Juniper Networks (NSDQ: JNPR) is a ‘hold’ in our Smart Tech 50 Portfolio

F5 Networks (NYSE: FFIV) is a ‘hold’ in our Smart Tech 50 Portfolio