Whenever I find a company that I might like as an investment, I always try to find anything and everything that might give me pause. I like to figure out what the worst things about a company are, then decide if the positives outweigh the negatives or if the negatives are overblown. There are times when the good news makes the current bad situation a temporal issue. Conversely, you can have a company like Cisco Systems (CSCO) that is in a great position from years of success, but past success is not a guarantee of future success. There are reasons to be positive about Cisco, but there are always potential pitfalls.
I think Cisco has a good management team that takes a stable and pragmatic view of things. For example, management was conservative in their projections at the end of Cisco's Q3, despite other companies having more upbeat guidance. I remember reading message board posts very angry with management. When earnings next came out the company beat the conservative outlook everyone was cheering the beat and the raised guidance for the next quarter. After lowering guidance before it is likely that the net increase in guidance was minimal. The market has a short attention span, but through its history Cisco has done well focusing on the long view. It is actually one of the reasons I am a fan of the company, because it has made drastic changes in the past to address serious issue. Examples include not dissolving after its supply chain disaster in 2001.
Cisco also offers a dividend. The move to grant a dividend brought that generation of technology companies into maturity, and was a great way to reward shareholders. Cisco's stock no longer moves like it did before 2001. Cisco is not IBM with its long storied history as a blue-chip stock. Its name was made during the internet boom of the 90s. The dividend finally establishes the tech industry in the zone of safe stocks looking for consistent returns rather than fantastic growth. However, I have a few concerns about Cisco's technological innovation rather than administration.
While I come down hard on Cisco here, I am just highlighting some worrying signs. I really do like Cisco and think it is undervalued. It should be around $25, not stuck around $20. I also think it has the potential to achieve better returns into the future if it makes the right moves and does not stumble. If my concerns become serious problems the value of company will come down to the share price instead of vice versa, and then might continue dropping further.
Lack of 4G LTE Small Cells
I dislike Cisco's lack of LTE small cell wireless devices. Alcatel-Lucent (ALU) has its great lightRadio cube. It also recently secured a financing agreement so there is something to cheer about over there, since it addresses some of the liquidity questions surrounding the company. Cisco is developing small cells, but there is no product out yet. Ericsson (ERIC) also has its own small cell system. Small cells complement large cell towers to plug gaps, but I see their importance going further than that as the spectrum crunch becomes worse.
Small cells of the traditional variety that work on spectrum make the use of it more efficient. Normal cell towers are also ugly with a nasty tendency to interfere with each other if deployed too tightly.
ALU's lightRadio can be put closer to the ground avoiding the interference caused by buildings, and would be great for achieving fantastic service in densely packed cities. ALU also has another version that incorporates Wi-Fi with the potential to be tracked by the companies.
Ericsson offers small cells as part of a larger solution. It forms one layer of a wireless network, which includes different kinds of macro cells. Ericsson's solution also includes, 3G, LTE, and Wi-Fi.
An impediment to Wi-Fi adoption is that companies cannot charge for the data used unlike cellular data. This limitation is removed from these gateway-less Wi-Fi systems, which recognize your phone and log you in automatically. The carrier can meter your Wi-Fi use. While it will be cheaper than cellular data, it will still be profitable for the companies due to the high volume that comes from its superior speed. It also removes the burden of having to acquire a ton of spectrum just for data. Wireless spectrum is extremely expensive, and setting up Wi-Fi zones everywhere there is cellular service through these small cells would be a great cost saving measure as spectrum becomes even more expensive and limited.
Cisco has products that integrate into a small cell solution, and have products for 3G. However, LTE is the future and the company does not have a complete solution for LTE small cells. Cisco does have a 3G and Wi-Fi small cell solution. Now it is focused on the LTE small cells, but other companies have had that for a long time now. Cisco is far behind. It is touting its Wi-Fi solution and saying it will focus on 4G LTE small cells.
Ericsson and Alcatel-Lucent have 4G LTE small cells with Wi-Fi options already available or on the cusp of being available. ALU's 4G LTE lightRadio gets all the attention, but I think the Wi-Fi version will be more important in the long-term. There is a maximum amount of licensed spectrum available, and Wi-Fi can keep service standards high and costs lower. Physics is not suddenly going to allow more spectrum, because you do not want to be shooting microwaves, even if possible, to check your email.
The Threat of Software-Defined Networking
Juniper Networks (JNPR) acquired Contrail Systems beefing up their SDN capability, although the benefits may not be realized for some time. This is an oblique attack on Cisco's hardware dominance rather than a direct strike. VMware (VMW) also scooped up an SDN firm called Nicira, which really sparked off the SDN craze. I am not sure that craze is the right word considering that SDN while being mentioned here and there has not gotten that much press. Maybe I missed it when it was last flavor of the month. Everything is a big deal while its being talked about.
SDN seems like a normal thing for VMware to get into since the company is all about software minimizing the need for hardware. Juniper is probably using SDN to improve its performance by avoiding butting heads with Cisco. SDN is a threat to the standard hardware business. Now Juniper is saying that there is no box, it is only a myth, or at least any old box will do. Go with us and free yourself from the metal and silicon yoke. It probably is not as dramatic as that, but it should be if only for the sake of staying interesting.
Cisco purchased its own SDN company, though it has a different focus. Cisco's purchase added features to its traditional platforms. Juniper's acquisition aims to develop a network that seems to be hardware agnostic. I am not a networking expert, but a fan. The parallel that I see is how a desktop computer does not differentiate between processors made by two different companies. What your computer can and can't do is normally up to the software with the hardware just providing basic limitations, although exceptions exist as with most things.
Do I think SDN is a Cisco-killer? No, not yet, but I have to look into this far more. I am more read up on wireless technology than networking technology. Cisco is massive and in my opinion undervalued. The problem is that the company's strategy seems to treat SDN as an incremental update, while VMware and Juniper want something more disruptive. Although a more recent deal seems to show that Cisco is trying to develop its own SDN solution. The deal has not closed yet, so it remains to be seen how Cisco will unfold its SDN strategy. Cisco has had some problems keeping talent when it comes to SDN.
Even if Cisco can create an SDN solution, it will be joining other companies that might be ahead of it. It may see an attrition of its classic hardware business, and that is a real threat. Even companies that do their best to keep up with the trend will be harmed by disruptive technology. The old way of doing things is entrenched into the very fiber of the company. Changes and innovation can help, but if the shift in the industry is so severe they can get sidelined by a leaner, nimbler company that can offer focused products and services. Or it can get replaced by a large company with a lot of resources that bet heavily on the new technology.
Cisco will still be focused on its normal hardware business. Perhaps SDN will not destroy hardware-based networking, but what if it surprises all of us and does. Even if Cisco jumps into this brand new technology it might not be able to compete on the level of more focused players. The first instinct is generally focusing on what you always did well. Think about Research in Motion or Motorola, which were fantastic companies when their technology was ascendant, but did not innovate with the times. These are common examples, because it is hard to give up on what has been making you so much money. By the time you realize you are behind the curve it is often too late. This mostly stems from the reality that you cannot know if something new will be successful and supplant something old, making it harder to justify investment. That investment can be better spent doing what you are already doing, but bigger and more expansive. In hindsight obsolescence it might seem inevitable, but you have to wait for hindsight.
Remember, I really like Cisco as an investment. I think it deserves to be at $25 now, and it has a history of reinventing itself when things went too far south. We may not be able to rely on the company continuing to change well with the times, but at least it has done it before.
The current economic situation really hurts the growth of Cisco's core business. If the malaise lasts while other companies are busy innovating behind the scenes, then when demand growth returns it might fall into newer products. SDN falls into this category. I still need to read more on the technical aspects of SDN, but it has the potential to remove the need to go with a full system from one vendor. It would be good enough to buy the cheapest equipment you can get, and use SDN to get the functionalities and capabilities you need. It is similar to how you can have an OS in the cloud, and you use stripped down machines as an interface rather than a computing device.
Cisco's lack of small cells is not especially problematic. Small cells are thought to be lucrative, and a growth industry. SDN is more of a direct attack on Cisco's core business. Not expanding into a closely-related avenue does not doom a company into irrelevancy. Wireless technology now has far more in common with networking than it did 10 years ago. However, if SDN delivers on all the little promises and makes hardware-based networking far less important, then it could be a problem for Cisco. Especially, if Cisco bets on the wrong path.
Onto the positive portion of our show. Cisco is still in a very strong position. It has a fantastic amount of cash, $45B, with a healthy profit margin. Last quarter was above 17%, which I like to see because it means there is a cushion before the company posts losses. Unless something extreme happens you will see a decline coming. More importantly, it gives the company time to make positive changes without having the fundamentals suffer for a bit. Alcatel-Lucent wishes it had a small profit while doing its restructuring rather than doing it under the shadow of losses.
Other aspects of Cisco's business like more traditional networking offerings that intersect with mobile data are doing well. Cisco does have Wi-Fi access points and is helping lead the way on establishing the relevance of Wi-Fi outside of the home and Starbucks. I never like to input usernames and passwords to Wi-Fi hotspots, even that little acceptance of terms is annoying, though I doubt that will go away. So Cisco is not completely wedded to the way things are, and really the concerns I have regarding SDN are that Cisco's strategy turns out to be the wrong one. That is a concern for every company not unique to Cisco.
One last thing when choosing between the other companies I mentioned. I would go with Alcatel-Lucent over Ericsson, because I like lightRadio much better and Alcatel will rise fast if it manages to get on its feet. Ericsson is not a bad investment, but it does not have a product I really like. I also do not see it moving very far past the $10 mark. When choosing between VMware and Juniper for more an SDN focus, it is too early to tell. Juniper just bought the company, however VMware is a pretty hot stock. Juniper has had some trouble lately and trouble can create opportunity. Revenues have lagged at Juniper. If these recover it should provide a nice return. However, when against Cisco, I would always choose Cisco, and watch developments closely in case I need to reevaluate.
Additional disclosure: Do not forget to do your own due diligence.