By Ruchi Gupta
Cisco Systems Inc. (CSCO), which has a market cap of $130 billion and a stock price of around $24, is the leading manufacturer of Internet switching and routing equipment. Its products are the backbone of the internet and what makes home computing and mobile computing possible. As a result of its dominance in the internet network and communication industry, it has earned competitive advantages over its competitors.
Cisco reported its fourth quarter earnings on August 14th, and once again it displayed its ability to grow earnings while maintaining a truly impressive balance sheet. The company reported revenues of $12.42 billion, up 6.2% on a year over year [YOY] basis. Net income was $2.23 billion up 8.6% on a YOY basis. These numbers were slightly higher than predicted, but close to what we have come to expect from Cisco. The company's CEO John Chambers had predicted an increase in revenues from between 5% to 7%, and the company's 6.2% increase was within the range of his prediction.
Despite beating analyst estimates, Cisco's stock price took a beating because of lowered first quarter forecast and the announcement of further job cuts. On August 15th, Cisco's stock priced dropped 9.3% on more than double the normal trading volume. The reason for the price drop was because during the earnings call John Chambers predicted that the company's first quarter revenues would be between $12.2 and $12.5 billion. This was lower that analyst estimates of $12.72 billion. He attributed the lower estimates to falling sales in Japan and China.
Also during the earnings call, John Chambers announced that the company would be laying off 4,000 workers or about 5% of its workforce. This comes on top of 7,800 layoffs in 2011 and 2012. Mr. Chambers said that the reason for the layoff was because "We just have too much in the middle of the organization," he said." While Cisco executives would have us believe that they have learned to do more work with fewer employees, and that leaner is better, investors have to wonder if the company can continue to increase output if it continues to layoff employees.
What is in Cisco's Future?
Cisco currently gets about 50% of its revenues from selling servers and routers, but John Chambers believes that the company must make changes in order to continue increasing revenues. The changes that Mr. Chambers wants to make include increasing the company's ability to provide computer software products and services. The company made moves to achieve that goal through acquisitions. In just the last three years, Cisco has spent $10.61 billion to acquire 59 companies. Nine of Cisco's last ten acquisitions have been of software companies, and as a result of the acquisitions, a majority of its 26,000 engineers are software specialists.
During 2013 alone, Cisco made eight purchases, six of them have been of companies which will help it to increase its ability to deliver cloud-based solutions and services. Two of its purchases were of cyber security companies, which will help them to compete in the internet security arena.
Cisco's most recent purchase was of Cariden Technologies, a network management software company for $141 million. Cisco said that the acquisition:
will allow providers to enhance the visibility, programmability and efficiency of their converged networks, while improving service velocity.
The purchase will be completed in the company's first quarter.
On July 23rd, the company completed the purchase of Sourcefire Inc. (FIRE) for around $2.7 billion. Sourcefire is a cyber security company that markets anti-hacking software that is used extensively by the U. S. Government.
Moving forward, Cisco's problems are twofold. The first is the slowdown of the economies in China and Japan, which is a variable that Cisco has no control over.
The second is the increased competition that they are receiving from companies like F5 Networks (FFIV), Juniper Networks (JNPR), Hewlett Packard (HPQ) and Alcatel-Lucent S. A. (ALU), in their routing and server businesses. Companies like Oracle Corporation (ORCL), Palo Alto Networks Inc. (PANW) and Fortinet Inc. (FTNT) are strong competitors to their cloud software and cyberspace security business.
The increased competition has forced Cisco to hold down prices so that they can compete with their low-priced competitors. In addition, the competition has hurt the company's margins and slowed its revenue growth. In the fourth quarter, the company's gross profit margin slipped to 59.2% down from 70.1% a decade ago. It is still too early to know if Cisco will be successful in its attempts to become a diversified hardware, software and service company. However the company is undisputed leader in the fast growing server and router market, and that is not likely to change.
Cisco's Financial Strength
Despite the reduced first quarter earnings forecast, Cisco is financially strong. The company has increased revenues in each of the last 10 quarters. In addition, its balance sheet is extremely strong, with cash and equivalents of $50.6 billion versus debt of just $16.2 billion. In the fourth quarter, things continued to get better as the company had a positive cash flow of $12.89 billion.
The recent blow to Cisco's stock price has given investors a chance to buy the stock at a discounted price. Cisco is not a stock for short investors that like to trade, however, the company is a good investment for long-term investors. It offers consistent growth of 5% to 7% per year and a dividend that has increased by 183% since 2011. Also the stock is relatively cheap, and with a price to earnings ratio of 13.05 and a price to book ratio of 2.2, some consider it to be a bargain. These attractive valuations are despite the fact that the stock price has increased by over 28% in the last 52 weeks. I believe that Cisco's stock will quickly recapture its recent losses, and will be profitable for investors that have a long term investment horizon.