On a recent call with a regional manager from web conferencing company WebEx, (WEBX) I asked him how things were going at WebEx and he told me that business was great. It reminded me of the last recession when business travel fell off a cliff after the dot com bust and web conferencing companies were doing brisk business. That brisk business attracted networking giant Cisco, (CSCO) prompting the company to acquire WebEx in 2007 even as it eyed bigger fish with its more expensive high-end videoconferencing product called TelePresence.
WebEx generated $380 million in 2006 annual revenues, the year before Cisco's $3.2 billion acquisition. Even if revenue has more than doubled since then, WebEx would account for less than 2% of Cisco's $39.54 billion fiscal 2008 annual revenue.
What attracted me to Cisco had little to do with WebEx and a lot to do with Cisco's current valuation. With a product portfolio ranging from enterprise routers, switches and hardware firewalls to consumer facing products like Linksys wireless routers and WebEx, the company generated over $12 billion in operating cash flow last year. The company has a stellar balance sheet with over $31 billion in cash and investments when compared to less than $7 billion in debt, representing net cash of over $4/share. Inventory levels have been dropping over the last four quarters and Cisco is positioning itself for negative growth this year and potentially next.
Valuation: Cisco's P/E ratio hit a 10 year low on March 9, 2009 when it dipped to 10.81. Since then the stock has rebounded more than 20% and trades at a current P/E ratio of 13.38 or an EV/FCF ratio of just 6.95 The company posted a 16% drop in year-over-year non-GAAP quarterly earnings and gross margins have also been contracting. Net margins are holding steady due to cost cutting initiatives that will eliminate nearly $1 billion in annual expenses at the current run rate.
To arrive at a value for Cisco, I decided to use a discounted cash flow (DCF) analysis model and used very conservative numbers to arrive at a price of $22.17 ($18.17 from the model and $4 in net cash). In case you are interested, the inputs into the model were $1.88/share in free cash flow over the trailing twelve month period, negative earnings growth of 5% for the next two years followed by a conservative 5% growth rate for the next 3 years (current analyst estimates are 9.85% for the next five year), a conservative 2% terminal growth rate and a 12% discount rate. Obviously changing any of these inputs will yield different values. The current stock price for Cisco represents a 32% discount to this $22.17 value and I think Cisco could be a compelling stock to own at these levels.
Conclusion: After the strong market rally over the last three weeks, I am expecting the market to pull back and consolidate in the coming weeks. Hence I am going to add Cisco to the watch list for now and will post an entry on the blog (or tweet) should I decide to start a position in the company.