EqualOcean held an interview with the company’s chairman Luo Dongping. We discussed Hillstone’s technology and new opportunities in the network security business.
► Since its founding, Hillstone Networks has placed great emphasis on R&D and established competitive advantages through technological innovations. Hillstone has pioneered technologies such as distributed parallel security processing with multiple processors and applying data analytics to security.
► In Chinese and overseas network security markets, there are no all-encompassing and dominating players leading the development of the entire industry.
China as a country suffers the highest losses from cyberattacks in the world, losing USD 66.30 billion in 2017. With the buildup of new infrastructure related to 5G and the maturing of the Internet of Things (IoT), network security issues will become even more important.
We conducted an exclusive interview with Luo Dongping (罗东平), chairman of Hillstone Networks, to look for answers to the following questions: What kind of changes will the ‘new infrastructure’ initiative bring to China's network security industry? Will this present a systematic development opportunity for the network security industry, and what are the directions for future development?
Hillstone Networks (688030:SH) is a company providing self-developed network security solutions for enterprise customers in various industries.
The company's operating revenue mainly comes from three areas: perimeter security, cloud security and other security categories. As a relatively mature business, perimeter security revenues were CNY 579 million, about 86.30% of the combined operating incomes in 2019. Among the main products included in this business are the firm’s X and K series data center firewalls capable of terabit performance.
“Technology capability is more important than products,” said Mr. Luo.
Since its founding in 2007, the company has sought a path of differentiation through technology and innovations. It has been developing a security appliance based on distributed parallel security processing with multiple processors. “‘Parallel’ means that multiple cores within a processor are doing security processing at the same time and ‘distributed’ means in the system, tasks are divided and assigned to numerous processors," Luo Dongping explained. “This architecture offers superb security processing performance and flexibility, but the technology is also very complex and engineering difficulty is extremely high.”
To stay on the technological edge and deliver competitive products, the company keeps investing in R&D. In 2016, the related expenditure was over CNY 120 million; it rose to CNY 187 million in 2019. With the increase in operating revenues, the proportion of R&D expenses as a percentage of revenue decreased from 37.10% to 27.70% over the same period.
The distributed firewall product released by Hillstone in 2010 integrates multiple processors into one device, which improves the processing performance of a single device. It quickly stood out in the market and laid the foundation for the performance advantages of Hillstone firewalls. Today data center firewall Hillstone X10800 can reach 1Tbps, and, as shown in the table below, is in direct competition with those from other global vendors.
Hillstone is also active in the overseas markets. Since 2014, the company has been conducting a pilot reaching out to different regions, mainly Southeast Asia and Latin America, and has achieved initial results. At this time, Hillstone has an overseas headquarters and an international marketing team in the United States.
“If network security can't keep up, the industrial Internet will be a sandcastle,” said Mr. Luo.
For the ‘new infrastructure’ initiative, Luo Dongping believes that the construction of information networks, energy networks and transportation networks will inevitably drive the demand for network security. There will be new networks and new applications that need to be protected,
because the damage under any breach will be much worse due to the more connected nature of businesses and society.
IDC predicts that the total investment in the global network security-related hardware, software and service markets will reach USD 120.28 billion in 2020, an increase of 10.10% from 2019. For China's network security market, the market size will reach USD 8.75 billion, an increase of 24.00% year-on-year from 2019. Among large economies, China continues to lead in terms of the growth rate of the domestic network security market.
With the gradual implementation of the ‘new infrastructure’ initiative, Luo Dongping is particularly optimistic about cloud security and industrial Internet security.
From the company’s 2019 annual report, the revenues of cloud security accounted for 5.32% of total revenue, a year-on-year growth rate of 50.08%. In addition, 8.38% of income came from other security areas, up by 124.87% compared to 2018. The high growth rate of these areas means they will account for higher proportion of the company revenue. The company has increased investment in the cloud security segment and has been expanding the product portfolio to meet the diverse needs of customers.
“At present, there is no systematic development opportunity that has swept across all sectors in the industry,” said Mr. Luo.
In the field of network security, there is no dominating player leading the development of the entire industry. Among the US’s network security companies listed on NYSE or NASDAQ, the market capitalization of Cisco is the highest, 24 times larger than the fifth-ranked Juniper. But the revenues in 2019 from its security business were only USD 2.4 billion, USD 2 billion less than that of Juniper.
"The fundamental reason is that there are many network security segments, and the product forms for those segments are different. For example, in security hardware, we have firewalls, intrusion detection and prevention among others. In many cases, there are special customizations needed to meet different requirements. As a result, there are many niche markets that are quite different from one another," Luo Dongping analyzed.
In terms of the future development of the industry, Mr. Luo pointed out that, "In network security, there are two resources which will become more important in the future. One is 'big data' or 'security intelligence,' and the other is 'inline security,' which is critical in customer infrastructure. Security companies that control these resources can complement their own businesses by investing in and acquiring other network security companies, integrating the entire industry to grow into giants. This may be a trend in the next decade."
Mr. Luo points out that, with the rapid implementation of the ‘new infrastructure’ initiative, the rollout of 5G networks and intelligent manufacturing, the material foundation of the Industrial Internet will soon be available.
Regarded as the most critical support for new technology implementation, network security is projected to be positively affected by the Chinese government's 'new infrastructure' initiative. Hillstone, as the company possessing related experience and technology, is seemingly well-positioned to benefit from the upcoming changes.
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EqualOcean’s understanding of the major business risks facing Hillstone Networks
Among the most critical areas in tech, network security is projected to be positively affected by the Chinese government's 'new infrastructure' course. Hillstone, as the company with the right experience and technology, has some advantages and can probably catch more market share in the future. There are a few other problems though:
1) The US published bans on high tech companies in China, preventing any company using US software or technology to do business with some Chinese companies without specific US approval. Among them, the semiconductor industry is related to the development of Hillstone, which needs chips for its firewall hardware.
2) Whether the company can successfully continue to expand in the overseas market is hard to say. Revenues from the overseas market generally increased from CNY 11.07 in 2016 to 17.23 million in 2019, the proportion range was between 2.6% and 3.7% in the four years. In addition, the profit margin in the area is lower than the local market. The profitability and growth opportunities in the overseas market are not certain.
3) Not only will Hillstone benefit from new infrastructure, but also local players in the same industry. Competition from companies in the domestic market is increasing: the scale and competitiveness of competitors continue to increase, and the number of new entrants gradually rises.
4) It is hard to compete against major foreign players, especially outside of China. The market value and revenue of the network security provider are much lower than those of its American counterparts mentioned in the table above. The company thereby has less free capital to invest in R&D. For instance, in 2019, California-based Juniper spent more than USD 955 million to foster innovation – approximately 36 times Hillstone’s USD 26.19 million invested that year.
However, Hillstone has certain advantages in some niche markets. As a niche player, its R&D investment seems enough to be competitive in its selected niche. In fact, in some market segments, small companies have a robust competitive advantage over their larger rivals.
Considering these situations, the company still needs to keep investing in R&D and expand the business border to improve competitiveness. Also, it should grasp the development opportunities from the ‘new infrastructure’ and increase the market share. If so, it is possible that Hillstone will be as large as some network security firms in the US. In order to respond to increasingly stringent US regulations, Hillstone also needs to find suitable alternatives.