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Summary

  • Cisco recently raised $8 billion in debt to refinance its previously outstanding debt at lower interest rates, pay off dividends and finance share buybacks.
  • The most recent blow to Cisco came from Spherix Inc., who sued the former for patent infringement.
  • Cisco has decided to invest $1 billion in cloud computing service that will put the company in direct competition with Amazon, Google, Microsoft, HP, IBM and VMware, among others.

Cisco Systems Inc. (NASDAQ:CSCO) is a tech giant that designs, manufactures and sells IP-based products and services. The company has spread its roots across the world divided among three geographic segments: the Americas; EMEA (Europe, Middle East and Africa); and APJC (Asia Pacific, Japan and China). As of the recent quarter's report, 58% of the revenues were attributable to the Americas, 25% to EMEA and the remaining percentage to the APJC region.

Second-quarter earnings reported on February 14th, 2014, beat the revenue and EPS estimates, while the company also announced a raise in dividends. However, the stock price still trended downwards after the earnings announcement, considering the fact that the overall performance of the company remained rather weak throughout the company's recent history. Since the start of this year, Cisco's earnings have been trailing downwards across all geographical regions, with a slump of about 8% YoY indicated by its recent quarter's report. Among all the geographical segments, the Americas has shown the largest drop in revenue generated (-9.5%). Analysts are expecting the revenues to drop by an additional 7% by the end of the current quarter and by an aggregate 4.50% by the year-end. A declining top line is never a good factor for the underlying stock, and this is one reason why the stock has been losing value.

With regard to returns generated to investors, Cisco distributes profits among its shareholders in the form of cash dividends and share repurchases. Cisco's dividend yield presently stands at 3.45%, in an industry where 1.13% is the norm. In addition to that, the company has decreased its share count from 7.5 billion outstanding shares to just 5.38 billion shares; this translates into an annualized decline of 2.29%. The reduction in share count boosted the per share earnings of the company. By year-end 2013, the EPS figure showed an increase of approximately 25%. However, over the recent quarter, EPS has declined owing to declining margins. Towards the end of the previous year, Cisco added another $15 billion to the share repurchase program. Over the recently ended quarter, the company bought back shares worth $4 billion, while another $12 billion worth of shares will be purchased over some time in the future. The company has not announced any termination date for the program.

Cisco recently raised $8 billion in debt to refinance its previously outstanding debt at lower interest rates to pay off dividends and to finance share buybacks. In my opinion, raising this debt is a smart move on Cisco's part. Note that almost $42 billion of Cisco's $47 billion are stuck in its overseas operations. If the company withdraws that cash in order to fund its investor returns, it will have to incur additional costs. Now that Cisco has been able to raise debt at very low coupon rates of about 2.3% on 5-year notes, the debt raised has actually saved the company some money. Additional money will be saved as the company pursues its share buyback program that will leave the company with fewer shares on which it is obligated to pay dividends.

With a dividend yield of 3.45% and debt interest rate hovering around 2.3%, the implied pretax savings of 1.15% of the share price will accumulate to the company, compared to what would happen if the debt had not been issued. The company will continue to enjoy this benefit as long as the share price remains below $33, at which point the dividend yield will equal the debt coupon rate. Note that we are not even considering the tax savings on debt in this scenario, which leads me to believe that there would be a much higher stock price threshold than $33 per share in the presence of debt savings.

The most recent blow to Cisco came from Spherix Inc. (NASDAQ:SPEX), who sued the former for patent infringement. In my opinion, this lawsuit is partially responsible for the recent drop in price. Spherix blamed Cisco for violating about 11 of the company's patents, and went on to allege that a large part of the company's $43 billion sales were accounted for by violation of these patents. However, this lawsuit is not the only factor causing a plunge in the stock price. The company is facing some major macroeconomic headwinds in the emerging markets as well, that account for at least 20% of the company's revenues.

To make up for some of the plummeting top line, the company has decided to invest $1 billion in cloud computing services that will put the company in direct competition with Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT), HP (NYSE:HPQ), IBM and VMware (NYSE:VMW), among others. The company will focus its efforts on building an inter-cloud service that will allow its customers to build interconnected networks. The move is not expected to add much to the bottom line of the company; however, the market is already very much saturated, and Cisco is a relatively late entrant to the party. Plus, the company does not have much experience in this field. Nevertheless, there is still a lot of room for the company to add value to this market.

Right now, I would recommend the stock as a value investment based on the significant returns expected to be distributed among the shareholders through increasing dividend payouts and share repurchase programs. As far as the growth is considered, the potential seems rather limited to me.

Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: Cisco - All Value And No Growth