From 2006-mid 2011, Cisco (CSCO) was suffering a "mid-life crisis" as a technology company. It could not accept that its revenue growth rate was becoming more correlated to global GDP growth; especially since its market share in most of its networking technology businesses (e.g., Routing and Switching) was very high and unlikely to expand. The company established aggressive revenue growth targets (i.e., 12%-17%) and then chased this growth objective through entering a multitude of new markets, many of which were non-core and low margin like Consumer or too embryonic like Smart Grid. The company spread itself too thin, became bureaucratic through the creation of boards and councils. As a result of this strategy, the stock was a poor relative performer during most of this period.
In mid-2011, however, Cisco abandoned the aggressive growth strategy as it finally realized that large revenue and capitalization technology stocks are more likely to appreciate and outperform the overall stock market by showing stable business models with steady or expanding profit margins, growth in earnings greater than global GDP growth, earnings that are less volatile during recessionary periods, maintaining strong market share in their core businesses and delivering capital returns to shareholders in the form of a solid dividend yield. The stock bottomed in early August 2011 just before the company reported its July fiscal year end results, at which point Cisco announced it would abandon the prior aggressive growth strategy.
Since the change of strategy in 3Q 2011, Cisco has taken many positive steps for shareholders including:
- - Significantly raising its dividend and seek to maintain a 3% yield
- - Selling the lower margin Linksys home networking unit
- - Innovating in its core Routing and Ethernet Switch business through new competitive products and unique cost reductions (i.e., integration of new ASICs and optical modules obtained through acquisitions of CoreOptics and Lightwire)
- - Outlining a vision and strategy for emerging disruptive technologies in the networking industry such as Software Defined Networking (SDN)
- - Acquiring high margin innovative private companies in secular growth areas such as Meraki for mid-market Wireless LAN and Intucell for Mobile Self-Optimizing Networks
- - Acquiring high margin, more mature companies like NDS for video operating systems to help protect and potentially expand its fairly high gross and operating margins of about 63% and 28%, respectively
Shareholders have been rewarded by Cisco's actions, as the stock is up 17% so far in 2013 and the company pays a dividend yield of roughly 3.2%, taking into account the recently announced dividend increase of about 21%.
While things are going well for Cisco and its shareholders, one thing to watch going forward is whether the company makes a bold move in the form of a large acquisition in the Software industry. Cisco has publicly stated it wants its Software business, which was about $6 billion in sales in fiscal 2012 and 13% of total sales, to double in five years to $12 billion and represent 25% of total company revenues. Cisco, however, is targeting overall revenue growth of 5%-7% over this period. Thus, a doubling of software sales to $12B over that period would get software to be about 20% of sales, shy of the 25% stretch goal.
In the past, whenever Cisco has set a multi-year revenue target for a major new business, the company has often relied on relatively larger acquisitions to achieve the target. An example of this was Cisco's entry into the video TelePresence market in late 2006. This was an exciting announcement from Cisco and the company felt at that time that TelePresence would be one of the fastest-ever growing businesses at Cisco and reach $1 billion in sales within 5 years. Roughly three years after announcing TelePresence, Cisco announced it would acquire the much larger video systems company TANDBERG for about $3 billion in October of 2009. Cisco's own TelePresence products were only generating about $100 million a year in revenue vs. the $1 billion 5-year target. TANDBERG was already generating about $1 billion in annual sales when Cisco acquired it. After three years of announcing its TelePresence solution, Cisco realized it would not hit the $1 billion sales goal organically and used a fairly large acquisition to achieve the goal.
With Cisco's new goal of reaching $6 billion in annual SW sales within 5 years and potentially SW reaching 25% of total company sales within that period, the question to monitor over the next couple of years is whether Cisco will get antsy and seek to either accelerate its timeframe in achieving this goal or realize a large acquisition will be needed to achieve it. Adding to this dynamic is the fact that the company's CEO John Chambers is 63 years old. While John is still a very dynamic and energetic CEO, he will not be CEO of Cisco forever. It is probably fair to assume that John retires from Cisco within the next five years. My sense is John would like to achieve Cisco's bold new SW goal before he retires and be at Cisco if the company were to make a large software acquisition.
Wall Street has speculated on potential software companies Cisco might acquire to scale the software business. The names most commonly referred to are Broadsoft (BSFT), Citrix (CTXS) and BMC (BMC). While there is merit to the thought process for each of these companies, it is not truly obvious which software company Cisco would acquire if it decides to acquire one, and I would not suggest investors own any software stock on the thesis Cisco will acquire it.
My sense is Cisco will get antsy and potentially seek to do a larger software acquisition in the next couple of years. The arguments above support this view. In addition, the maturing of the IT industry has led to increasing competitive dynamics between "Big IT" companies such as Cisco, EMC/VMware, HP, IBM and Oracle. In the last year or so, we have Cisco VMware acquiring Cisco competitor Nicira in the Software Defined Networking (SDN) market, and Cisco fund start-up Insieme and Oracle announcing acquisitions of two telecommunications policy and control companies Acme Packet and Tekelec. This heightened level of convergence between "Big IT" companies, I think, will only exacerbate Cisco's push into software.
Additional disclosure: NT Advisors LLC is a consulting firm that provides consulting services to the technology, private equity and venture capital industries.