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Do Weak Growth And New Challenges

Make Cisco A Value Trap?
By Stephen D. Simpson, CFA on May 07, 2014 \l "A A A
Filed Under: Tech n!"st#y, Technical $ System So%t&a#e, Technolo'y, ()"ity
Tickers in this Article: CSC*, +,-, BM, .M/
A %#"st#atin' #eality o% tech in0estin' is that the#e1s #eally no competition 2et&een '#o&th
an! 0al"e3 a2sent '#o&th, 0al"e sel!om e0e# matte#s eno"'h to mo0e a stoc4. That1s a
p#o2lem %o# San 5ose, Cali%.62ase! Cisco Systems !nc" 78as!a)9CSC*:, as this lea!in'
net&o#4in' company is not loo4in' at pa#tic"la#ly #o2"st '#o&th anytime soon. Ma4in'
matte#s &o#se, in0esto#s &o##y that th#eats li4e so%t&a#e6!e%ine! net&o#4in' 7SD8: an!
clo"! se#0ice plat%o#ms &ill e#o!e the company1s ha#!&a#e 2"siness at an e0en %aste# #ate.
Cisco sha#es loo4 "n!e#0al"e! i% the company can '#o& its cash %lo& at all, 2"t in0esto#s
no& seem to #e'a#! that as a 2i' ;i%.< This co"l! 2e a 2it too ne'ati0e a position, 2"t
in0esto#s consi!e#in' Cisco nee! to ha0e a lot o% patience to #eali=e the 0al"e that may
#emain he#e.
SDN !s Coming #ut Timing Magnitude Are $nknown
So%t&a#e6!e%ine! net&o#4in' th#eatens to "n!e#mine the s&itchin' 2"siness that has lon'
p#o0i!e! Cisco &ith a la#'e ch"n4 o% its #e0en"e 66 a#o"n! >0? at last co"nt. ,alo Alto,
Cali%.62ase! %ewlett&'ackard Co" 78@S(9+,-: an! (uniper Networks !nc"
78as!a)958,A: o% S"nny0ale, Cali%., 2a#ely o%%e# a se#io"s th#eat to Cisco in s&itchin',
2"t the s&itch to SD8 co"l! "n!e#mine a lot o% the 0al"e that Cisco has 2"ilt in this
2"siness.
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/ith P"st these > F#ee #epo#ts yo" co"l! 2e t#a!in' 2y !ay1s en!.
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Fin! o"t &hich stoc4 ma#4et a!0iso# #a4e! in 1>.>?A* 1H yea#s st#ai'ht
So%t&a#e6!e%ine! net&o#4in' %eat"#es a cent#ali=e! cont#olle# &ith a complete 0ie& o% an
enti#e net&o#4 an! 4no&le!'e o% all paths an! capa2ilities, allo&in' it to 2est #o"te
t#a%%ic th#o"'h the net&o#4 as con!itions chan'e. This allo&s a net&o#4 ope#ato# to "se
cheape#, less sophisticate! ;&hite 2oN< s&itches as the cent#ali=e! cont#ol plane ta4es
a&ay the nee! %o# sma#t s&itches that #eco'ni=e an! mana'e !i%%e#ent types o% pac4ets.
The th#eat, then, is that the SD8 o%%e#in's o% companies li4e ,alo Alto62ase! VMware
!nc" 78as!a)9.M/: an! Microso)t Corp" 78as!a)9MSFT: o% Ae!mon!, /ash., &ill
se#io"sly "n!e#mine the 0al"e o% Cisco1s s&itches. So %a# the implementations o% SD8
ha0e 2een limite! an! it1s not al&ays as easy as a!0e#tise! to s&ap o"t a net&o#4 o% sma#t
s&itches %o# mo#e commo!iti=e! s&itches. *0e# time, tho"'h, the#e is a #eal #is4 that
SD8 cont#olle# o%%e#in's %#om .M&a#e an! othe#s &ill sh#in4 the ma#4et %o# Cisco1s
hi'h60al"e s&itches.
Cisco isn1t stan!in' a#o"n! &aitin' %o# this to happen. The company is !e0elopin' its
o&n SD8 capa2ilities an! is also p"shin' its ;Application6Cent#ic n%#ast#"ct"#e< that
"ns"#p#isin'ly maintains a #ole %o# Cisco ha#!&a#e.
Can Cisco 'ut !ts Cash To Good $se?
Inli4e A#mon4, 8.@.62ase! !nternational #usiness Machines Corp" 78@S(9BM: an!
Santa Cla#a, Cali%.62ase! *racle Corp" 78as!a)9*ACM:, Cisco !oesn1t ha0e a
pa#tic"la#ly 'oo! histo#y o% 0al"e6a!!e! M$A. The company1s eNpensi0e %o#ays into
0i!eo ha0en1t #eally a!!e! 0al"e an! it1s "nclea# that its So"#ce%i#e ac)"isition &ill
maintain the company1s lea!e#ship in the %ace o% ent#enche! competito#s o# ne& playe#s
in the sec"#ity space. Mi4e&ise, the company hasn1t al&ays !one a 'oo! Po2 o% i!enti%yin'
oncomin' th#eats, s"ch as Seattle62ase! +, Networks !nc" 78as!a)9FF.: in application
!eli0e#y cont#olle#s 7ADCs: an! hea!in' them o%% th#o"'h ac)"isition o# competiti0e
#esponse.
As tech companies mat"#e, s4ill%"l M$A 2ecomes mo#e an! mo#e impo#tant. Ae%e##in'
2ac4 to BM an! *#acle, a la#'e pe#centa'e o% the most competiti0e 2"sinesses the#e
&e#e ac)"isitions. De0elopin' m"ltiple s"ccess%"l 2"siness is 2eyon! the capa2ilities o%
most companies an! Cisco nee!s to 2e 2ette# a2o"t i!enti%yin' 4ey ac)"isition ta#'ets to
maintain its #ele0ance in the chan'in' T ha#!&a#e an! so%t&a#e ma#4ets. To 2e %ai#, this
is not a Cisco6eNcl"si0e p#o2lem, as neithe# 5"nipe# no# +e&lett6,ac4a#! ha0e #eally
!istin'"ishe! themsel0es &ith 'oo! M$A. t1s also impo#tant %o# companies to #eco'ni=e
&hen it1s time to eNit a 2"siness. BM is pe#haps the 2est eNample o% this, as the company
has 2een &illin' to sell o%% maPo# 2"sinesses 7pe#sonal comp"te#s an! NJO se#0e#s, %o#
instance: once it 2ecame clea# that the '#o&th o% the ma#4et an! the company1s position
&e#e no lon'e# 'oo! eno"'h to ea#n accepta2le #et"#ns.
Not -nough Growth !n A Growth&%ungry Market
By most #easona2le meas"#es, Cisco is not an eNpensi0e stoc4. The company1s ma#'ins
an! #et"#n on capital a#'"e %o# 2ette# m"ltiples to sales, (BTDA an! 2oo4 0al"e than the
ma#4et c"##ently 'i0es the stoc4. In%o#t"nately, that1s P"st not ho& tech typically &o#4s3
#e0en"e '#o&th has a !isp#opo#tionate in%l"ence o0e# tech stoc4 m"ltiples an! c"##ent
estimates a#e callin' %o# P"st a 1? #e0en"e CAFA 2et&een %iscal 201> an! %iscal 201O.
Foin' %o#&a#!, eNpect Cisco to see some ne'ati0e impact %#om SD8 an! a shi%t to&a#!
clo"! in%#ast#"ct"#e se#0ices 2"t it sho"l! still still post lo& sin'le6!i'it '#o&th. F #ee cash
%lo& 7FCF: '#o&th sho"l! 2e ne'li'i2le, tho"'h, as Cisco sho"l! see ma#'inBFCF !e6
le0e#a'e. (0en &ith minimal '#o&th, tho"'h, a !isco"nte! cash %lo& mo!el s"''ests a
%ai# 0al"e in the hi'h R20s.
The #ottom .ine
t1s 'oin' to ta4e time %o# Cisco sha#es to !eli0e# on the potential s"''este! 2y a
!isco"nte! cash %lo& mo!el. The#e1s a #is4 that the company1s #e0en"e an! FCF come in
e0en lo&e#. Ai'ht no& the#e1s a '#eat !eal o% pessimism #e'a#!in' Cisco1s a2ility to
compete an! '#o&. That pessimism co"l! pass 2"t it1ll ta4e some time, ma4in' CSC* a
to"'h stoc4 to #ecommen!. The 0al"e seems to 2e the#e, 2"t the St#eet1s %ea#s &ill ha0e to
p"t to #est %i#st.
Disclosure: as of the time of writing, the author owned shares of EMC, the majority
owner of Mware!