Cisco Systems Inc. (CSCO) shares dropped 13% after the dismal 2nd quarter guidance was issued by the company with the release of its 1st Quarter Financial Report last November 13. The Cisco guidance estimates a revenue reduction of as much as 10% for the current quarter.
The market immediately reacted to this news by selling-off Cisco's shares. At least 17 brokerage companies reduced their price targets for Cisco. Goldman Sachs (GS) is one of the brokerages that cut Cisco's target price from $30 to $25. Barclays (BCS) also lowered their objective price for the stock from $27 to $25.
Why the Gloomy 2nd Quarter Forecast
Cisco justified their weak 2nd Quarter 2014 revenue forecast by pointing to lower sales orders. Based on its 1st Quarter report, orders fell 4% - which is a big disappointment considering their sales went up by 4% in the 4th quarter of fiscal year 2013. There's a huge 13% drop in service provider (telecom companies) orders. Add to this the 12% reduction in sales in emerging markets. India and China were also a big disappointment, -18% sales in those countries.
The company also revealed that the U.S. government shutdown this year affected its 1st Quarter sales by $50 million. Cisco says the challenging political environment in China has a great negative impact on their operations in that country. This government-initiated hindrance in China is most likely a political backlash from Albert Snowden's revelation that the U.S. government is spying on foreign government and citizens.
China's government, while not officially prohibiting the purchase of Western-made products, has issued directives to Chinese corporations to source out networking and telecom equipments first from Chinese manufacturers like Huawei. Due to this political backlash, Cisco will continue to bear the brunt of negative growth in China, India and other foreign markets where politicians are aggressively expressing their displeasure at the U.S. government's spying activities.
The 10% negative revenue growth for 2nd Quarter 2014 is therefore a realistic assessment by Cisco. The company sees a consistent drop in orders due to the reasons mentioned above. It only sees a possible turnaround by August 2014 when revenues from its cloud-centric ventures start producing enough sales to offset the reduced pipeline from its core networking products.
Buy on the Dip
The collapse of Cisco's stock on November 14 offers a sweet opportunity for bargain hunters. Cisco is a cash-rich company facing temporary, mostly politics-related, headwinds. As of October 2013, the company has a fat war chest of $48.2 billion in cash and equivalents. It can easily weather a business down cycle of one to two years duration.
If the stock price drops into the teens, Cisco is going to be a perfect bargain buy. The company is fundamentally sound with a great balance sheet. It's a solid cash-generating tech company that has a long history of year to year profitability despite its slow growth rate.
If fiscal year 2014 proves to be a total downturn for Cisco, say a 10% in reduction in both sales and net profit figures, Cisco's share will most likely go as low as $17. It will be just for the short-term. The company has the financial muscle to make a full recovery by tapping out new channels of revenues. It has already started to diversify its business and Cisco is effectively penetrating the cloud services market.
Cloud-centric Products Will Propel it to New Heights
With its widespread global infrastructure and long-term relationships with major global Fortune 1000 corporations, Cisco has a great chance of dominating the new shift towards the cloud for data center operations. The company, contrary to what critics are saying, is also willing to adapt new technology for its core networking business. Cisco has a sound master plan for software-defined networking (SDN).
The company is again leveraging its almost-monopolistic presence in enterprise IP networking by pushing out its SDN product, Application-Centric Infrastructure to its existing customer base. Cisco's tactical move to aggressively promote its Application Policy Infrastructure Controller (APIC) is to lock-in customers. Competing vendors are correct to say Cisco is twisting the open-platform SDN concept to suit the company's need.
Cisco is just trying to protect its vast hardware assets. This is why it demands that switching for ACI SDN services should always be wholly-controlled by Cisco even though other Layer 4-7 vendors can also use ACI through APIs. This lock-in strategy has done well for Cisco over the past decade and it will continue to do so for the next decade as the company branch out to the Cloud.
Buy Cisco now at $21 and just hold it for at least a year. Do not fret too much if the stock goes down to $17 or even lower. Buy some more stocks if the price keeps going down into the teens. You will recoup the losses when Cisco finally shows a great sales result of its cloud-centric products. If Cisco hit $25 at the end of 2014, then you made a tidy profit. Goldman Sachs, Barclays, and other investment firms that cut their target price of Cisco still recommends a BUY for Cisco.
The political backlash it is experiencing now is just temporary. Politicians come and go and multinational corporations always find a way to win favor again from foreign governments. The U.S. government spying on other countries is an open-secret anyway. This issue will hopefully go away soon so that Cisco can sell more products in China, India, and other emerging countries.