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Cisco Systems (NASDAQ:CSCO) continues with inorganic growth in cloud computing and mobile technologies. The company has reported strong quarterly results as it looks for growth in non-core areas by selling servers and other equipment as opposed to the traditional communications equipment such as routers and switches. This transition was apparent in the current quarterly results in which strong growth in data center, wireless and service provider video made up for the lackluster performance of switching and NGN routing - two of its biggest business segments. The two units are also under pressure from the increasing popularity of the relatively cheaper and flexible software-defined-networking, or SDN, technology.

However, the irony here is that while SDN is going to reduce the hardware needs of Cisco's customers, new research has shown that the demand for SDN equipment, which will form the backbone of this software based technology, is going to considerably increase in the coming years. Cisco, through its SDN technology, could play a significant role in this growing market.

Earnings: traditional vs. non-traditional

Cisco has recently reported its quarterly results for the three months ending in April, that were above analysts' estimates. The company's software and services units have delivered a strong performance, which is making up for the weak sales of its networking products.

Cisco has beaten both top and bottom-line estimates. Its revenues rose 5.4% year-over-year to $12.21 billion, ahead of the market's expectations of $12.18 billion, while its net income increased by 14.5% to $2.5 billion or $0.46 per share. On an adjusted basis, earnings rose by 4.7% from the same quarter last year to $2.7 billion or $0.51 per share, 2 cents above estimates.

Cisco's traditional Switching business reported a 2% drop in sales while NGN Routing was flat but the equipment sales for Service Provider Video, Data Center and Wireless units increased by 30%, 77% and 27% respectively. Analysts have identified that the Unified Computing Systems products and the Nexus data center servers could very well be worth $5.5 billion in business in the near future. This is a tough environment where the company will face competition from HP's virtual router, Arista's new 7500E high density switch, Huawei's 16-slot switches (CE12816) and Facebook's Open Compute Project, which is reportedly working on a data center switch.

Revenue of Businesses

Businesses

2013

YoY % change

(In Million)

Switching

$3,598

-2%

NGN Routing

$2,140

0%

Service Provider Video

$1,299

30%

Collaboration

$1,013

-1%

Data Center

$515

77%

Wireless

$523

27%

Security

$327

-4%

Other Products

$144

-41%

Services

$2,657

7%

SDN: challenge and opportunity

The switching and routing equipment make up for 47% of the total revenues and 60% of the total product revenues of Cisco. As indicated above, the segments are under threat from SDN. According to recent estimates, in the next five years, the size of the SDN technology market will exceed $35 billion. In the near future, firms are going to significantly increase their SDN spending, which currently form 2% of the total expenditure and would increase to 40% by 2018.

Ironically, most of this spending will be on hardware. If Cisco continues to come up with more successful SDN-enabled products then it will turn this threat into an opportunity, which will work well in the near term. This is already happening as, according to the study by SDNCentral, most of the $200 million that the companies have spent this year to upgrade their equipment to make it SDN-enabled was on Cisco's products.

Here, Cisco is taking its Cisco-ONE (Open Network Environment) strategy forward that will use the Nexus 6000 and the new Nexus 1000V Intercloud switch for SDN. The Cisco ONE SDN Controller supports both Cisco's ONE Platform Kit as well as OpenFlow. Last year, Cisco also acquired the SDN firm Cariden for $141 million. Two weeks later, its rival Juniper (NYSE: JNPR) acquired the SDN controller maker Contrail System for $176 million. Juniper will release its JunosV contrail controller, which forms the foundation for the Juniper's SDN strategy, in the first half of 2014. Meanwhile, Cisco's secretive spin-in Insieme is rumored to be working on SDN technology, such as a high-density fabric controller, which would enhance Cisco's existing portfolio but no official word has come out yet.

Stock Update

Cisco's stock is currently trading near $23.80 and has gone up by 25% in the last six months and is ahead of the S&P 500 ETF (AMEX: SPY), which is up 18.3% in the same period. Cisco has also outperformed Juniper, which is up 2%, and VMWare (NYSE:VMW), which is down 18.4% in the last six months.

Citigroup has been bullish on Cisco and believes that the shares could touch $30 if it continues to deliver strong earnings. However, I believe that crossing, or even touching the $30 mark, which happened back in November 2007, in the near future, given the current competitive environment, is highly optimistic. However, Cisco is attractive at the current level. Citigroup has reiterated its buy rating with a price target of $26. Similarly, Nomura Securities has also raised the price target to $26.50.

Source: Cisco's Growth, Software-Defined-Networking 'Threat' And The New Price Target