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Despite a challenging environment in some of its key markets, Cisco (NASDAQ:CSCO) reported strong financial results for the latest quarter (fourth-quarter 2013).

The company reported fourth-quarter revenue of $12.4 billion, and showed net income of $2.3 billion or $0.42 per share. The Americas and EMEA regions grew by 7% and 12% respectively. However, the APJC region delivered negative growth of 3%.

In Q4, Cisco's total product orders grew by 4% (year-over-year). Once again, the Americas and EMEA regions showed the positive trend and grew by 5% and 6% respectively; APJC region delivered negative growth of 5%. Country-wise, Israel grew by 27% and India grew by 18%, while China showed negative growth of 6%.

Despite the good results, the company decided to cut about 4000 jobs or 5% of its workforce and also lowered its own expectation for the current quarter. As per the company's latest earnings call transcript:

For Q1 FY '14, we're managing the business to account for a slow and consistent recovery. With that in mind, we expect revenue growth to be in the range of 3% to 5% on a year-over-year basis."

"we are rebalancing our resources with a workforce reduction, which will impact approximately 4,000 employees or 5% of our global workforce. (Source: Seekingalpha)

Stock markets didn't take any of these statements positively as the share price of the company fell down (see the table below). I am of the view that some of these events are positive developments as far as the future of the company is concerned. I believe that Cisco follows one of the best strategies to grow, and the recent layoffs are part of its long-term strategy. The company offers all that I want to see for a long-term investment. Discussed below are some factors that make me believe that the company is an excellent long-term investment, particularly after the recent slide in its stock price.

CSCO Chart

CSCO data by YCharts

With the sales of over $48 billion in FY 2013, Cisco is a leading global provider of networking, data transfer and communication solutions. The company is currently trading at about $23, with the market cap of about $125 billion. Even though the company lowered its guidance for the near term, it's one of the best large-cap companies to invest in due to the reasons mentioned below:

  1. Its aggressive growth strategy.
  2. Its attractive valuations.
  3. Its significant presence in high-growth segments.
  4. Its knowledge of the industry in which it operates.

1. Aggressive growth strategy

The company follows an aggressive growth strategy, i.e. rapid acquisitions, and heavy spending on R&D. It believes in acquiring new and well developed technologies rather than concentrating on just self-developed technologies.

The company is known for acquiring new companies/technologies, and has had a long list of acquisitions for the last few years. Almost all its acquisitions are at first look expensive. For any other company, this kind of approach towards acquisitions may not work for long, but for the company this is a very successful approach, and the reasons behind this are: its vast and global, "selling and marketing" capabilities (its global sales and marketing department consisted of approximately 24,500 employees as of July 28, 2012), and its strong customer relationships. The moment the company makes an acquisition, the acquired technology/product gets many times more exposure to an end-user industry, where otherwise it had very limited exposure. This exposure makes it sure that revenue from the product/technology increases rapidly, to pay off the acquisition costs.

The latest example of the success of its acquisition strategy is Meraki, a "Cloud enabled network" company, which the company acquired in the 2012 for about $1.2 billion, according to the company's latest transcript:

We were particularly pleased with the performance of our cloud networking business based upon our acquisition of Meraki, this quarter which grew orders over 100% from the prior quarter within order run-rate now annualizing Q4 of over $250 million. (Source: Seekingalpha)

The company makes most of its acquisitions in high-growth segments and in technologies that are expected to be the future of the industry. Due to its acquisition strategy, today the company is delivering the industry-leading technologies (particularly in software & services). In fact, last year (FY 2013) most of the growth in its revenues came from the segments where the company had made acquisitions in the recent past. (See the table below)

(click to enlarge)

The company's current layoff plan (discussed above) is just part of its acquisition strategy as it seems that the company is abandoning some of its old technologies and related talent to concentrate more on the new technologies and related talent.

2. Valuations are attractive

The company is trading at PE of 12.5x ("TTM") with the market cap of about $125 billion. It offers the dividend yield of about 2.9%. So, the valuations look very attractive.

  • Enterprise value and cash position:

The $125 billion is not the net enterprise value of the company, as it also holds the huge amount of cash and cash equivalents ($34 billion, net of debt), which makes its valuations even more attractive. So, the actual enterprise value of the company comes down to $91 billion, which makes the valuations even more attractive.

  • Investor's return:

Despite the heavy spending on the acquisitions and on repurchase and dividends, its cash position has been showing, nearly, constant increase for the last few years. (See the table below)

(Source: Annual Report 2012, 2009; FY 13 balance sheet, Income statement.)

This cash position shall make it sure that the company can carry on with its repurchase program and dividend payouts as well as with its acquisition strategy (a key factor behind its long-term growth potential), in the years to come and even in the difficult times.

Significant presence in the high-growth segments

The company generates the significant amount of its revenue from the high-growth segments like: Data enter (cloud), Wireless, Security, Service provider video. In-fact the company generates over 43% of its revenues from these high-growth segments and services. Discussed below are some reasons that why some of these segments are expected to generate high growth in the future.

  • Data center:

Due to the cost-effectiveness of cloud computing the global IT industry is rapidly shifting towards cloud computing. The basic infrastructure need of the cloud computing is the data centers, which can handle the cloud computing requirements like virtualization, remote security, high speed connectivity, multiple levels of access points, etc. All over the world, data centers are transforming themselves to meet the requirements of cloud computing.

Cisco itself predicts (Cisco Global Cloud Index) that global data center traffic is expected to grow fourfold and reach a total of 6.6 zettabytes annually by 2016. The company also predicts global cloud traffic, the fastest-growing component of data center traffic, is expected to grow sixfold from 683 exabytes of annual traffic in 2011 to 4.3 zettabytes by 2016. The global cloud traffic will account for nearly two-thirds of total data center traffic by 2016.

This shall be a massive business opportunity for the company as well as for the industry in the years to come as the global data center transformation needs rapid installation of new infrastructure and upgrading of existing storage and networking infrastructure. This will not only generate the business for the company's hardware products but also generate the business for the technologies that the company has acquired in the recent times e.g. online security (SourceFire).

  • Wireless:

Due to the rising popularity of handheld devices (mobiles, tablets, etc), the sale of high-speed wireless devices is expected to show phenomenal growth. The number of high-speed wireless devices sold is expected to break the 150 million unit mark by 2017, from 75 million in FY 2013. Due to the rising number of wireless devices in the market, the demand for wireless networking is expected to show similar growth.

Moreover, the Software as a Service ("SAAS") and cloud-based business application services is expected to grow from $13.4 billion in 2011 to $32.2 billion in 2016, a five-year CAGR of 19.1%; this will further increase the need of wireless networking (WAN, LAN), as SaaS is commonly accessed through the Internet.

  • Security:

The rising use of the cloud computing means more and more data are being stored on the remote servers. This data are mostly accessed through the Internet. As the global IT sector is rapidly shifting towards cloud computing, new security threats are emerging every passing day, particularly through the Internet. Moreover, with the rising use of virtualization, now even a single server may hold the data from different clients that further increase the security threats and need for the new-age software technologies that can secure this multiple user remote data access. The company already has its presence in this field (online security) through the recent acquisition of Sourcefire, which provides the most advance online security solutions. The demand for advance security solutions should rise in tandem with the cloud computing.

Its knowledge of the industry

The company is managed by a very experienced team, and most of its management members have been working for the company for more than 15 years. The management's long-term engagement with the company makes sure that the management understands the strengths as well as the weaknesses of the company. This understanding plays a vital role when it comes to the acquisitions and R&D efforts. The company's R&D efforts are focused on the core strengths of the company, and its acquisitions are focused on the new technologies that fit its core business, but the company had not built-up the R&D capabilities in technologies. The benefit from this experience reflects in its recent acquisitions, which are mostly concentrated on high-growth segments.

Conclusion

Valuation-wise many large-cap companies look attractive, but all don't hold the same growth potential as Cisco. The company holds a significant growth potential due to its acquisition strategy, and its balance-sheet that can support its acquisition strategy even in the difficult times. Moreover, the company clearly understands that:

  • Its core business doesn't have much growth potential in near to medium term (particularly due to the slowdown in the emerging markets),
  • It can't develop all the required technologies that are needed by the latest networking standards, and
  • It needs to constantly integrate new technologies into its core business through the acquisitions to stay ahead of its competitors.

The company not only knows what it needs, but the company also knows its strengths:

  • It has a very strong customer base and
  • Very strong, global, selling and marketing capabilities.

So, the company understands that even if it acquires the new technologies at expensive valuations it can still get a lot of value in the long term, and most of the time even in short term, due to its business strengths. One more thing, which differentiates the company from other companies is that it usually doesn't acquire start-ups, instead it normally acquires:

  • The companies that are well into the business and
  • The products/technologies that already have been commercialized (may be on a smaller scale).

I certainly believe that the company is an excellent long-term investment (unless something drastically goes wrong), and the company holds a lot of growth potential that its current valuations don't reflect.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Disclaimer: Investments in stock markets carry significant risk, stock prices can rise or fall without any understandable or fundamental reasons. Enter only if one has the appetite to take risk and heart to withstand the volatile nature of the stock markets. This article reflects the personal views of the author about the company and one must consult its financial adviser before making any decision.

Source: Cisco Holds Significant Growth Potential