Cisco (NASDAQ:CSCO) is moving aggressively to strengthen its cloud-based services portfolio and software capabilities through new acquisitions. The networking giant recently showed its intent to acquire SolveDirect, an Austrian-based provider of cloud-based solutions for IT services management integration and services. One of SolveDirect’s key products that Cisco is looking to add to its services portfolio is the ServiceGrid platform which allows organizations to efficiently integrate with service partners by automating the real-time exchange of data, workflows and processes without manual intervention. The need to share a growing amount of data through secure and scalable means is causing enterprises to increasingly move to the cloud – a trend that Cisco is looking to address through its recent spate of software- and cloud-related acquisitions.
Apart from SolveDirect, Cisco has made a number of software-related acquisitions such as Intucell, Clariden, ClearAccess and ThinkSmart Technologies in the past year. The company has also been actively investing in the cloud. It released a virtual cloud-routing and WAN optimization platform under the Cisco Cloud Connected Solution brand and acquired a small cloud-based networking firm called Meraki last year.
These acquisitions show that the company is moving towards a more software- and services-based business model. The fact that Cisco is actively focusing on the cloud and investing in software-based networking solutions is a good sign for the future and shows that its restructuring and turnaround efforts have realigned the company’s focus on key growth areas in the networking business. With data demand exploding and restructuring initiatives taking hold, we believe that Cisco is well-positioned to grow revenues at a healthy rate in the future.
As a result of the restructuring initiatives, the company has been able to keep its expenses low and make operations more efficient. This will help it meet its guidance of being able to grow earnings at a faster rate than revenues. Cisco’s recent quarterly results show that its operating margins, which were fluctuating widely as a result of the restructuring, are stabilizing at >20% levels. This increases confidence in management’s guidance of achieving long-term operating margins in the mid-20s and increasing profits at a faster pace than revenues.
Deeply undervalued at market price
However, due to macroeconomic uncertainty caused by the burgeoning debt levels of governments worldwide, corporates over the past year or so have become extremely cautious with their network spending. This has impacted the top-line growth of the networking sector as a whole. In this challenging business environment, Cisco continues to be conservative in its guidance for the future but has indicated that there are signs of a “soft global recovery” with parts of Europe still under distress.
Longer term, therefore, Cisco’s outlook looks strong not only due to an industry-wide change of fortunes as the uncertainty eases but also the company’s bigger market share within the industry. The company’s strong market position has helped it outperform rivals Juniper (NYSE:JNPR) and Alcatel-Lucent (NYSE:ALU) in an uncertain economic environment so far, and will help it even further when the concerns subside.
In line with this view, Cisco’s stock has risen more than 20% since it announced a solid set of Q1 FY 2013 results in November. Despite rallying more than 20% since its November lows, we still believe that the company is being undervalued at these levels and see far more value in the stock coming from Cisco’s renewed focus on its networking division.
We maintain our price estimate of $26.50 for Cisco, which suggests 25% upside to the current market price. This takes into account the slowly recovering demand for networking gear, the company’s moves to target upcoming trends, and its long-term plan of achieving stable operating margins in the mid-20s.
Cisco also has tons of cash – more than 27% of its current market capitalization. It has also been generating huge positive cash flows in the order of billions from operations every quarter despite a challenging economic environment. We believe the company will continue to execute well on its turnaround plans, banking on a leaner structure to grow its profits at a rate higher than revenues. The positive cash flow ensures that the company is able to return cash to shareholders through regular dividends and share repurchases while keeping its powder dry for other strategically-important acquisitions.
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