Cisco Systems Is Upgrading Its Networking Offerings To Be More Software Defined

Sep.27.13 | About: Cisco Systems, (CSCO)

Cisco (NASDAQ:CSCO) investors now should be less concerned about the company's ability to continually dominate the networking equipment business, as Cisco has been quickly adapting to the increasingly software-defined networking infrastructure used by today's Internet service providers and other corporate and government customers for Web communication and data management. In the past, networking equipment mainly dealt with the amount and speed of data traffic flows within particular networking infrastructure. For Cisco, the task was also to supply networking equipment that could carry data for customers as much and as fast as possible. Networking infrastructure nowadays, however, is not only about the bandwidth, but increasingly tied to data management, including data warehousing and integration, issues that only software applications can fully address.

In essence, Cisco is transforming itself from primarily a hardware maker of networking equipment to become also more of a software service provider to help customers solve broader data management issues that arise more often now when transporting data within their networks. Such networking infrastructure capable of both moving and managing data often is referred to as software defined network, or SDN. Like much of everything else in today's wider and more innovative use of the Internet, software plays a more dominant role, be it in consumer mobile applications or business computing functions. Increased user efficiency and client productivity are likely the result of better information handling through data management, which can be made possible only by using more software-defined hardware.

Although such a transformation sounds daunting, Cisco has made it easy through its usual game of acquisitions. Having a vision about the future of the networking equipment business may have proven far more difficult than subsequently devising a plan for implementation. Cisco's latest acquisition of Composite Software, a data virtualization specialist, is only one of the many pieces that the company can plug in to solidify its position in supplying customers with next-generation networking infrastructure. The data management expertise from Composite Software can be of great use for Cisco when it comes to organizing for customers the increasing flow of data generated by the so-called Internet of Things. With the accompanied data virtualization technology, Cisco will be able to build more intelligent networking infrastructure to improve the efficiency of its primary data movement task across networks.

Why is data virtualization a sensible solution to achieving such network efficiency? Data virtualization in plain terms is a software application offering the ability to access data of multiple sources within a network and then integrate them for analysis, but without the need to migrate different data to a central processing store. Prior to incorporating data vitualization software into its networking infrastructure, Cisco would have to provide networking infrastructure that might be less agile to accommodate the traditional data management approach of extracting, transforming and loading data all across a network, know as the ETL approach. Now using more software-defined networks, both Cisco and its customers can benefit from productivity efficiency, and potentially cost efficiency as well.

To make the best use of its Composite Software acquisition, Cisco may also position the unit as a stand-alone service to other networking and datacenter service providers that will likely see increased needs for data virtualization to help better handle their massive amount of data. As a result, Cisco will derive certain revenue as a software service provider. Over time, this service may drive more customers to switch to Cisco's networking offerings that already have built-in data vitualization functions. This is one way how Cisco can win over its competitors, including Juniper Networks (NYSE:JNPR), the number two networking equipment maker. Faced with the new SDN trend, Juniper seems to be less aggressive than Cisco in the pursuit of software-defined network integration via research and acquisitions. With a much smaller revenue base than Cisco, Juniper has been outspent by Cisco by large margins. This partly explains why Cisco stock performed better than Juniper's over the last three years that saw a lot of innovations in the expanded adoption of the Internet and networking by businesses.

Throughout its history as a public company, investors have rarely valued Cisco as a growth company that after all makes bulky networking equipment, and Cisco stock never traded too far above its equity book value, except during the time leading to the Internet bubble around 2000. Currently, Cisco stock is trading at less than three times the company's book equity. This low multiple could make the stock potentially a bargain but only if Cisco finally pulls out some breakthrough performance by taking advantage of this second-wave Internet innovation.

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.