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Summary

  • The company blames the environmental inconsistency for the drop in its geographical sales.
  • Growth in sales in the US and Europe hovered between mid-single digits, whereas it remained negative in the BRIC markets and Mexico.
  • The new low-cost technology, Software Defined Networking (SDN), is a major threat to the company's margins, as it replaces the need to invest in Cisco's high-margin products.

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; Europe, Middle East, and Africa (EMEA); and Asia-Pacific, Japan, and China (APJC). As of the recent quarter's report, 58% of the revenues are attributable to The Americas, 27% to EMEA, and the remaining 15% to the APJC region.

Cisco Systems (CSCO) slightly beat the earnings estimates over the recently ended quarter, with the EPS halting at $0.51 compared to the analysts' estimate of $0.48. Cisco's revenues stalled at $11.55 billion, compared to the Wall Street consensus estimate of $11.36 billion. The share price of the company increased approximately 7% in after-hours trading.

Although the results posted look great on the surface, let us dig deeper into the report. Compared to the third quarter of FY2013, the revenue base of the company declined 5.5% YoY and the bottom line fell by 12% YoY. However, adjusting for one-time events, the decline in the bottom line squeezed to just 3.2%, while the adjusted per share performance remained flat. Weakness was seen among the drop in demand for the company's hardware products, including its popular server and switching products, whose sales declined 7.7%; service sales showed an improved performance, however, and increased by 2.6% YoY over the period. Considering that hardware sales make up more than 70% of the top line, the blow is rather significant. However, improvement in the services segment cushioned the decline to some extent. Although Cisco performed better than what analysts were expecting, it is still trending downwards compared to its historical sales. Cisco's management had foreseen the drop in demand for its products last year, which led the company to slash its workforce by 5%, or 4000 employees. They also made a few investments to strengthen its competitive position in the future.

Geographically, the company performed better in the developed world, while popularity of its products remained low in the emerging markets, which are traditionally thought of as high-growth regions. To be precise, growth in sales in the US and Europe hovered between mid-single digits, whereas it remained negative in the BRIC markets and Mexico. Orders escalated by 7% YoY, with a marked increase of 10% in enterprise and commercial orders in the US, but order booking in the emerging markets faltered at the same rate, with a 27% drop recorded in Brazil and a 28% drop in Russia. Since these markets are responsible for generating 20% of the total top line, the blow is not as significant, but growth was negatively affected. Order bookings in Europe are gradually rising again, and grew by low single-digits.

The company blames the environmental inconsistency for the drop in its geographical sales, which I believe to be nothing more than an excuse. One has to take responsibility for determining changing market prospects and be flexible enough to change one's offerings accordingly. Cisco is not admitting its mistake of failing to bring forth a timely change. It is not just emerging markets that are showing a diminished performance, and if Cisco continues to move at its current pace, its margins in the developed markets will become negative as well. The new low-cost technology, Software Defined Networking (SDN), is a major threat to the company's margins, as it replaces the need to invest in Cisco's high-margin products. To counter it, Cisco introduced its Nexus 9000 switches that did dissipate competition to some extent; however, the transition to the new switches is rather slow, and it will take time to begin reflecting in the top line. Over the quarter, the user base of Nexus 9000 switches increased by 20% to 175 sequentially. However, its actual impact on the top line will be reflected far into the future.

Cisco has seen mixed performance across its different products over the quarter. Where the core businesses of the company are losing market due to an industrial shift in software that replaces most of the hardware needs, its growth units and "internet of things" effort does alleviate some of the concerns. Meraki and Sourcefire have been performing particularly well, but the company is not as strong as it once used to be. The need to invest in high-margin hardware products has largely evaporated and has been replaced by cheaper investments. I mentioned in one of my previous articles that Cisco is making extensive efforts to enter the cloud computing markets. It is still unclear if the company would be able to generate enough revenue from that segment to offset the diminished performance in its enterprises business. It seems rather implausible that the company would become a leader in said market given that competition is already high and Cisco is inexperienced when it comes to cloud computing.

There is a lot of uncertainty surrounding Cisco's future. Considering that Cisco is a late entrant to the cloud market, I believe that the company needs to look into other growth opportunities as well. Cisco is very strong financially, and is distributing ample amount of profits among its shareholders, but how long into the future are those paybacks sustainable? I am not saying that Cisco is too far gone, but the company really needs to up its game.

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.

Source: Cisco Needs To Pace Things Up Before It's Too Late