CEO John Chambers has made some bold statements in the press recently about Cisco's (CSCO) plan to disrupt the traditional wireless infrastructure market, which is currently primarily served by Alcatel-Lucent (ALU), Ericsson (ERIC), Huawei, and Nokia Solutions and Networks (NOK). Cisco claims to have funded a start-up as part of this disruptive plan. I believe Cisco aims to disrupt this market via Cloud-Radio Access Network (C-RAN) technology using new software programmable processors (likely developed by the start-up it is funding). Such an entry would complement Cisco's wireless offerings in Enterprise WiFi, Small Cells and Self Optimizing Networks (SON) and, if successful, open up another multi-billion dollar market for the company. In addition, C-RAN also fits with the Software Defined Networking (SDN) model, which is an area Cisco is aggressively pursuing. As for my view on Cisco's stock, I find the current risk/reward favorable.
In the past year, Cisco has spent $2.0 billion on three wireless related acquisitions:
Ubiquisys (3/24/13) - Cisco paid $310 million for Ubiquisys, which gave Cisco 3G/4G small cell technology primarily for the indoor segment of the market. Cisco likely will seek to leverage Ubiquisys's in-door small cell technology with its existing Enterprise Wi-Fi products for a complete Enterprise mobility solution it can sell to service providers. AT&T's aggressive plans for indoor small coverage probably played into Cisco's decision to enter this market via an acquisition.
Intucell (2/25/13) - Cisco paid $475 million for Intucell, which gave Cisco self-optimizing network software, which allows mobile operators to better plan, configure, manage, optimize and repair mobile networks based on real time changes in the network. Intucell had made progress with AT&T, which likely played a role in Cisco's decision to acquire Intucell.
Meraki (12/20/2012) - Cisco paid $1.2 billion for Meraki, which gave Cisco a superior Enterprise wireless solution with better cloud management features for the midmarket segment of the Enterprise market.
The $2.0 billion Cisco paid for these three acquisitions in the past year clearly shows that Wireless is a key part of Cisco's strategy although overall Wireless sales represent only about 7% of Cisco's total product revenues. While these acquisitions enhance Cisco's position in Enterprise wireless (both in Wi-Fi and licensed spectrum via small cells) and the software management of both small cells and macro cells in the service provider market, Cisco is not a competitor in the $40+ billion service provider wireless infrastructure market.
While Cisco has not disclosed how it plans to disrupt and enter the wireless infrastructure market, I believe the only disruptive path Cisco can pursue is via C-RAN. The premise of C-RAN is that wireless base stations will be centralized in the cloud, allowing for base station functionality to be centralized, thus dramatically improving utilization of wireless baseband performance. Centralizing base station processing will allow a mobile operator to more efficiently utilize base station assets while also utilizing less energy, also supporting a more environmentally friendly deployment of wireless networks.
C-RAN equipment will likely require new types of processors and fits into the disruptive Software Defined Networking (SDN) architecture, thus, providing a framework for Cisco to use C-RAN as a dislocation point to enter the wireless infrastructure market. Antennas will still be needed at cell towers as they are used today to receive wireless signals from wireless phones and devices, but the baseband processing would be done in the cloud.
C-RAN has technical challenges such as the implied need for ubiquitous fiber optic networks to connect the distributed antennas to the C-RAN and the need for very accurate synchronization. My sense is true broad commercialization of C-RAN is probably at least 2 years away. In addition, incumbent wireless infrastructure companies like Alcatel-Lucent, Ericsson and NSN are likely also investing in C-RAN technology to defend their market position. Thus, Cisco has a lot of work to do to be a disruptor in this market. China Mobile, the world's largest mobile operator by subscribers and capital spending, has been a major advocate of C-RAN.
In terms of Cisco's stock, the current valuation and more cautious sentiment going into the next earnings report scheduled for November 13th makes the stock look attractive relative to when we approached the last earnings report on August 14th. Historically, Cisco's stock does not trade more than 20% below a Discounted Free Cash (DCF) valuation that assumes 0% growth of future cash flows and a 10% discount rate even when using a full tax rate on international profits and cash holdings. Using this "worst case" 0% growth analysis and up to a 20% reduction of future cash flows, Cisco would be valued in the $20-$24 range, which is close to where the stock is today. Cisco tends to go to this low valuation when there is cautious sentiment on the stock or an economic recession. Given the weaker than expected guidance from last quarter, the current concern over US Federal IT spending and the overall slowing of GDP, sentiment on Cisco's stock currently is a bit cautious. Historically, however, Cisco has been able to grow, when global GDP grows. Using the same DCF analysis as above, but assuming Cisco can grow 2%-3% instead of 0%, the stock should be worth between $26-$30. Thus, my view is the downside of the stock is about 10%-15%, while the upside is 25%-33%, suggesting the risk/reward on the stock is favorable.
Additional disclosure: NT Advisors LLC is a consulting firm that may have in the past, present or future earned consulting revenue from any company mentioned in this article.