Cisco: Compelling at These Levels 16 comments
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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.
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This article has 16 comments:
@Jolly_Rancher, sentiment was extremely negative a few weeks ago and on 3/11/2009 I wrote on my blog:
"The powerful rally staged by the market yesterday from extremely oversold levels is being construed by some as the first rebound from a bear market low but most investors appear to have a more sanguine view, dismissing the rally as the start of a bear market sucker's rally. This negative sentiment leads me to believe that the rally may be more than a one day wonder."
www.sinletter.com/ablo...
The market is up 20% since then and I expect a pull back from these levels on Q1 earnings news. I could very well be mistaken.
Cisco did announce a huge $10 billion stock buyback in late 2007 (talk about timing) but buybacks have not even been sufficient to offset dilution from options granted to employees.
Like many companies nowadays, they are managed for the benefit of executives and employees, not shareholders.
They buy back stock to give their employees and to boost the price for the benefit of their executives' options. If the shareholders' money wasted on overpriced buybacks does not suffice to boost their options, they re-price underwater options, like Google just had the gall to do!
Meanwhile, shareholders get diluted and receive no dividends, just wait for the "greater fool" to pay them a higher price.
Boards are mostly stuffed with "good-ol-guys-and-gals", all they want is to stay on the board for the pay and perks, without regard to shareholders' interests. Most real shareholders do not vote or even know which companies they "own" because their mutual fund managers do it for them.
If the administration wants to reinstate a healthy stock market, they need to place restrictions on the governance of publicly traded companies to prevent management's abuse of their shareholders. The SEC, or perhaps the retirement oversight agencies, have this duty because much of the public have no option but to put their retirement savings in publicly traded stocks via their 401K's, and most don't even know what stocks they indirectly own, so they are being unwittingly fleeced. Companies that don't like such restrictions should either go private, or, at least, should be banned from ownership by "Joe the plumber's" 401K, and only be traded by individual investors who actually get to vote on corporate governance.
On Apr 08 05:43 PM Asif Suria wrote:
> Could not agree more on the dividends. Oracle finally found dividend
> religion just like Intel and Microsoft did and the stock appreciated
> sharply after the announcement. It is ironic that Oracle's dividend
> yield even at the time of announcement was just 1.25% and is probably
> under 1% now.
>
> Cisco did announce a huge $10 billion stock buyback in late 2007
> (talk about timing) but buybacks have not even been sufficient to
> offset dilution from options granted to employees.
You'll notice I asked Asif to tell us how much Cisco has accumulated in profit the past 15 years (still waiting)... in $ billions... no such luck. The company spends all the profit it books to repurchase the stock it dishes out to employees.
Asif should not to talk about dividends and buybacks in the conventional sense. After buying stock to fight the dilution coming from option exercise, there is no cash left for dividends. Sorry, Cisco shareholders, you will never see a dividend.
There is no benefit to shareholders when you inflate the share count with stock issued to employees and then you buyback that stock. FASB hasn't figured it out but for dummies like us, when you buy back the stock you've issued to employees you are paying compensation through the back door - forget about Black-Scholes... as Holmann Jenkins of the Wall Street writes... FASB 123R produces "junk numbers." Just folow the cash, you can't go wrong. Stay away from Cisco, unless you in it for a trade... more than one billion options coming down the pike... 20%+ dilution. You are not investing, you are bailing out excutives and monetizing their options.
If your mother-in-law's owns Cisco, tell her to sell the fund. The manager has no clue. That goes for all these stock option laden companies.
Asif, are you still bullish on Cisco?
On Apr 09 08:11 AM prudentinvestor wrote:
> Asif,
>
> Like many companies nowadays, they are managed for the benefit of
> executives and employees, not shareholders.
>
> They buy back stock to give their employees and to boost the price
> for the benefit of their executives' options. If the shareholders'
> money wasted on overpriced buybacks does not suffice to boost their
> options, they re-price underwater options, like Google just had the
> gall to do!
>
> Meanwhile, shareholders get diluted and receive no dividends, just
> wait for the "greater fool" to pay them a higher price.
>
> Boards are mostly stuffed with "good-ol-guys-and-gals", all they
> want is to stay on the board for the pay and perks, without regard
> to shareholders' interests. Most real shareholders do not vote or
> even know which companies they "own" because their mutual fund managers
> do it for them.
>
> If the administration wants to reinstate a healthy stock market,
> they need to place restrictions on the governance of publicly traded
> companies to prevent management's abuse of their shareholders. The
> SEC, or perhaps the retirement oversight agencies, have this duty
> because much of the public have no option but to put their retirement
> savings in publicly traded stocks via their 401K's, and most don't
> even know what stocks they indirectly own, so they are being unwittingly
> fleeced. Companies that don't like such restrictions should either
> go private, or, at least, should be banned from ownership by "Joe
> the plumber's" 401K, and only be traded by individual investors who
> actually get to vote on corporate governance.
Although you may think Cisco can just start tromping on others ground without pushback into their own sacred networking territory. And that IBM and others have no choice to buy high end networking equipment, you will probably be sadly mistaken. A billion dollars in tech funding by IBM and others can go a long way. Google started with much less.
If you are an accountant, sure go ahead and play this, but in the technology sector, accountant usually get trampled.
I have no position in Cisco or IBM but have been negative on Cisco for about a year for business model purposes mainly. You can see my prior comments on Seeking Alpha regarding this.
This was one of the reasons I used to stay away from companies like Cisco. Sooner or later shareholders will wake up and Cisco might follow Intel and Microsoft's path of offering a dividend. Intel in my opinion is taking all the right steps towards becoming a shareholder friendly company.
The point of my article was that Cisco appears attractive from a valuation basis and since the inputs used in the analysis on a per share basis, the analysis still holds unless one of my assumptions are off.
Point well taken on the accumulation of profits over the last 15 years. I did not respond as I have not yet had the time to dig through the records to compile the information.
Thanks for the response, Asif. Do you agree that cash spent on buying back stock issued to emloyees is paying compensation through the back door, hence such expenditures should be deducted from free cash flow, after which there is not much left. The balance sheet reflects it correctly and sets it off repurchases against retained income, thus there is very little in accumulated or retained earnings after more than 15 years of being a "profitable comany."
As an investor I am in your camp and prefer companies like PICO Holdings (PICO) that focus on shareholder equity as a reporting metric over a company like Salesforce.com (CRM), where a large portion of GAAP earnings goes towards options granted to executives.
Cisco could make a movie studio or link all the web cams of the world together from its giant cloud computing routers , accessed with our special computer connection to that big flat screen HD TV on my wall which could show the world. TIME WARNER has junk.
I have to stay up at night to watch what the
real world is doing because USA mega media stations give whinning , simple baby food programs.
A dividend would be nice but change the world we live in. Enter fuel cells to power laptops ..wall plugs are not where I am all the time. But CEOs are paid to sit.