Cisco (CSCO) has been on an acquisition spree this last year. The recent quarter results of Cisco also managed to beat consensus revenue and earnings estimates. The stock is trading at P/e of 9.6x (ex-cash 7x) and pays a dividend yield of 2.7%. I believe there is still more upside to CSCO based on strong fundamentals and low multiples. The stock is still trading below its 52 week high and I am setting a target price of $24, using a 12x multiple; 16% upside. Therefore I recommend investors to go long CISCO as there is still more upside available.
During the last few weeks Cisco Systems Inc has been in the news for all the right reasons. It all started with Cisco's announcement of its F1Q13 results. The company beat consensus earnings estimates by 4.5%, reporting an EPS of $0.48 and revenues of $11.88 billion. This is nothing new for this technology giant as it has managed to exceed analyst expectations for four quarters in a row. Cisco's management followed these outstanding results with the announcement of its intent to acquire Meraki.
A primary investor concern about companies that are trying to create value by acquisition is erosion of shareholder value. The recent Autonomy fiasco and failure of Hewlett Packard (HPQ) to protect the value of its shareholders is a prime example of all that can go wrong with a missed acquisition. While this is a legitimate concern, I believe the situation is different when it comes to CSCO. The company has successfully replenished its extinguishing sales from Routers and Switches segments with diversification of its core business. Since 2009, Cisco has added 5 new segments to its core business. As you can see in the Figure1, these new segments contribute approximately 30% to Cisco's revenues.
Figure 1: CSCO's Diversification Efforts
These new segments have enabled the company to support its diminishing growth rate. As you can see in the Figure 2, the falling revenues have been stabilized due to the addition of new segments. The orange line which represents the revenues had a downward trend before 2009 and is on an upward trend after addition of new segments. EPS is also showing a general upward trend but the share price does not reflect these positives. Therefore, it can be argued that the market has not priced the successful diversification of Cisco's business. The multiples remain similar to what they were before the 2009 turnaround, in CSCO's strategy. The Figure 3 shows the declining P/E and Market Cap despite growth increase in EPS and Revenues.
Figure 2: CSCO Stats Y-charts
Figure 3: P/E and Market Cap
Recent M&A make it clear that CISCO plans to continue focusing on driving growth through diversification. The company has announced a number of collaborations and acquisition, in the last couple of months. The company acquired Meraki last month, for $1.2 billion. Meraki is a US cloud based network infrastructure company. This is CISCO's eight acquisition in 2012 and would allow Cisco to target more mid-market customers because of the flexibility a smaller setup entails. Cisco's enterprise division is currently more focused on large enterprises and does not have the flexibility to cater to smaller organizations. The mid-market is particularly strong in emerging economies which makes this acquisition an excellent strategic move. The following are of some very recent collaborations and acquisitions by CISCO which can expand its multiples:
- Xerox and CISCO will collaborate to deliver Xerox's Global Managed Print Service through Cisco's Unified Computing System
- CISCO recently announced its Small and Midsize Business solution portfolio to its 300 channel partners, at the Asia Pacific, Japan and Greater China (APJC) Partner-Led Network Event. This venture will create a secure environment for partners looking to serve customers and increase their productivity.
- Extending its magnificent acquisition run, CISCO announced its successful acquisition of Cloupia earlier this month. Cloupia is a privately held software company that automates converged data center infrastructure. The company enables enterprises and service providers to improve and simplify the deployment and configuration of virtual and physical resources. Cisco has paid $125 million for Cloupia and retention based incentives, similar to its acquisition of Meraki. This strategy doesn't not only make the acquisition's negotiations easy but also allows Cisco to retain the talent pool.
- Yesterday, DataOne announced collaboration with Cisco, to enhance and update their product 'CloudSecure'. This a portfolio of services including software-as-a-service (SAAS), platform-as-a-service (PAAS), infrastructure-as-a-service (IaaS) and voice services over the cloud.
- The tech giant has successfully completed its acquisition of Cariden Technologies. Caridend provides design, network planning and traffic management solutions for telecommunication service providers. Through this acquisition, Cisco plans to improve its nLight technology for IP and optical convergence. The improvement would allow telecom service providers to enhance the utilization and programmability of network assets. This acquisition will also include the talent pool of Cariden Technologies.
CSCO is currently trading at a forward P/e of 9.6x, which is approximately 30% below its year high P/e TTM of 13x. A primary flaw with P/e valuation is the underlying EPS estimates. As recent Sell off in Apple (AAPL) has revealed, very high EPS estimates artificially shrink the multiples and give a false picture of company value. As the chart below shows, the consensus estimates have remained the same, over the last 18 months. This shows that the expansion of multiples was driven by improving growth prospects and not only EPS revisions. In the last few months, there have been no considerable downgrades/upgrades of Cisco's EPS.
Figure 4 : 18 months EPS esimates Source: 4-trades
The share price of a stock is also affected by the downgrades and upgrades of sell side analysts. As we can see below, the consensus target price has remained stable around $22. As the chart also shows, the stock price has appreciated, even without any price target revisions.
Figure 5: Analyst Price Target Source: 4-trades
This shows that the stock has appreciated on fundamentals and positive sentiment from acquisitions. The company currently has around $45 billion in Cash and Short term investments. This comes down to a per share amount of $8.5 per share or 42% of its market capitalization. The company has approximately $5.4 per share in Net Cash which can be used to calculate an Ex Cash P/e. The Ex-Cash P/e comes down to 7x ($14.5/2.1), less than half the sector average.
Cisco has successfully diversified away its maturity problems. The introduction of segments has ensured the stability of the company's declining growth rates. I am very optimistic about Cisco's excellent acquisition strategy and I believe it can successfully drive growth, especially in mid and small markets. The company also pays an above average dividend yield at 2.7% and a large cash basket shows this yield is sustainable. The stock is currently trading at a Forward P/e of 9.6x and ex cash P/e of 7x. Therefore I believe the company can easily cross its mean target of $22 and trade in the low 20's. If we value CSCO at industry average P/e of 12.2x, we can calculate a P/e price target of $24; potential 20% return on current levels. I believe Cisco is a buy at current levels and the market is still underpricing CSCO.