Cisco: Reversing The 'ABC' Trend

| About: Cisco Systems, (CSCO)

Cisco (NASDAQ:CSCO) has not only had a strong positive reaction to its earnings results this week, but its renewed focus in its core networking business, increasingly friendly shareholder actions via raising its dividend, and stability in its gross margin over the past year have all helped to reverse the prior "ABC" networking investment trend of "Anything But Cisco." Specifically, over the past 12 months, Cisco's stock has outperformed most of its networking peers, many of which are best of breed networking companies in their respective segments that had outperformed Cisco's stock in prior years. Specifically, over the past year Cisco stock has outperformed networking peers, Aruba (NASDAQ:ARUN), Brocade (NASDAQ:BRCD), F5 (NASDAQ:FFIV), Fortinet (NASDAQ:FTNT), and Riverbed (NASDAQ:RVBD). Cisco's stock has also outperformed its large IT peers EMC (EMC), HP (NYSE:HPQ), IBM (NYSE:IBM) and Oracle (NASDAQ:ORCL) over the past year as well.

This past year's outperformance is warranted and likely to continue given Cisco is now leading and distancing itself from its more diversified networking competitors in terms of vision and product depth. It is also using acquisitions of leading technology start-ups and bundling sales tactics across the entire enterprise customer base (i.e., from the campus to the data center) to more effectively compete against best of breed, single product area focused competitors. In particular, Cisco has improved its Mobility, Service Provider Video and Data Center product offerings via acquisitions over the past year (e.g., Meraki in Mobility, NDS in Service Provider Video and the spin-in Insieme effort in Data Center, which is likely to be formally announced this summer). In addition to these acquisition efforts, Cisco's has taken a leadership, rather than a defensive role in the emerging Software Defined Networking (SDN) market with its onePK and OpenDaylight efforts. The enhanced product offerings across these multiple technology disciplines within campus and data center networks within the enterprise has enabled a more successful bundling and end to end solution sell that Cisco can now utilize. It could not do this a year or two ago, given lack of a fully competitive product portfolio. It certainly helps when larger, broader based networking companies like HP and Huawei have struggled with broader corporate issues (e.g., bad acquisitions and a declining PC market for HP, and increased national security concerns in the U.S. and financing concerns in Europe for Huawei).

One area that Cisco has yet to truly turn around is its Security business. Revenues continued to decline this past quarter for Cisco in the Security business, while niche competitors like Palo Alto Networks (NYSE:PANW) and Sourcefire (NASDAQ:FIRE) are showing relatively better performance. It would seem that bundling security in an end to end enterprise solution would be something Cisco could pull off, but the company lacks enough technology leadership/products in this area. I would not be surprised to see Cisco now turn its acquisition engine to the security area given Mobility, Video, Data Center and SDN have garnered most of the M&A attention post the company's restructuring and change of strategy over the past couple of years.

While Cisco stock has been an outperformer over the past year and has had a strong upward move this week, it still trades at a forward PE multiple of about 11.5x Non-GAAP EPS and 12.5x GAAP EPS vs. the S&P500 multiple of about 14.6x. With Cisco offering a higher dividend yield of 3% than the S&P500 of about 2.1% and the company executing well on its strategy and business model, it would seem to me the stock can continue to go higher over the course of the year. What it decides to do in the security market and/or other software areas from an acquisition standpoint will be important to watch for the stock as well, as such actions can either be positive or negative catalysts for the stock depending on the company acquired and price paid.

Disclosure: I am long EMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: NT Advisors is a consulting firm that may solicit consulting services from any company mentioned in this article.