Cisco Systems (CSCO) is the Goliath to Juniper Networks (JNPR). This is the story of two companies, both providing switches, security systems, routers and other parts supporting the plumbing that runs communications systems, the internet and computer networks. Juniper, with sales of $4,282.3 million for the twelve month period ending March 2011 is dwarfed by Cisco’s $42,859 million. Considering the disparities in size, we ask the question, "Is Juniper the upstart growth company disrupting the marketplace so clearly dominated by Cisco?”
Juniper’s business strategy is to build its products and solutions to be compatible with the “open architecture” model and is directed towards the trends related to cloud computing and mobile access to the internet. This open architecture may be Juniper’s advantage in the build-out of new networks. On the other hand, Cisco’s advantage lies with a large installed base of legacy systems. When Cisco’s customers upgrade, they are more likely to stick with Cisco than switch to another vendor. This tends to preserve the company's investment in its legacy systems.
The two companies have grown market share differently, as well. Cisco is well known for being a serial acquirer of new technologies and customers. With its vast hoard of cash on hand, Cisco can buy whatever it wants. Juniper, being so much smaller, focuses on growing organically. Investor’s have voted on which horse they are backing. Over the past 52 weeks, Juniper shares have appreciated about 52% as compared to a decline of 29% in share price for Cisco. This begs the questions, “Are Juniper’s shares overpriced? Is Cisco undervalued?
On a quarterly basis, Juniper’s EPS reported for 1Q11 declined to $0.24 from $0.30 in the year ago quarter. Cisco’s EPS declined to $0.33 for 1Q11 from $0.37 in 1Q10. In the twelve month period ending March 2011, Juniper doubled EPS to $1.08 as from $0.53 year-over-year. Cisco’s growth was much less dramatic as EPS grew from $1.18 to $1.27. Growth rates for net income on both a trailing twelve month period and five year average are stronger at Juniper.
Juniper’s sales grew to $1,101.6 million in 1Q11 as compared to $912.6 million in 1Q10 or 21%. For the trailing twelve months, Juniper’s sales jumped to $4,282.2 million or 24% from $3,464.4 for the comparable year ago period. In comparison, Cisco’s sales were about 5% higher, $10,866 million in 1Q11 than the $10,368 in 1Q10. In the twelve month period ending April 2011, Cisco’s sales were $42,859 million or 14% more than the year ago sales of $37,739. Juniper’s sales growth rates are better than Cisco’s on a five year average basis.
For both the most recently reported quarter and for the trailing twelve months, Juniper’s growth has been significantly stronger than Cisco’s.
Gross profit margins at Juniper are higher than for Cisco, both on a trailing twelve month basis and for each company’s five year average. Both companies report most recent gross margins below their respective five year averages. On the other hand, operating margins are superior at Cisco.
Cisco pays a small dividend of $0.06 per share, generating a payout of a paltry 4.7%.
Both companies generate free cash flows that exceed reported EPS. Each company has a cash flow return on invested capital of about 15%-16%, underscoring strong cash flow generation. At 15.8%, Cisco’s return on equity is better than Juniper’s 9.0%. Both companies are more profitable than other companies in their industry. Both companies have very strong balance sheets with ample cash on hand and low levels of debt. Cisco has cash and cash equivalents of $43,367 million and Juniper $3,438 million. Cisco has increased its cash position every year since FY06 when it stood at $17,814 million. Juniper has also increased its cash position since FY06, but less consistently.
Warren Buffett famously said, “Value is what you get, price is what you pay.” Valuation is always an important factor when making an investment. These two companies are dissimilar in several ways. Cisco can be described as a mature company. It does not exhibit the high growth rates associated with “growth” companies. Usually, mature companies sell at low multiples. Juniper may be described as a classic growth company. Short-term EPS growth has been explosive and longer term growth is impressive. Some investors are willing to pay a premium for growth. How much should the premium be?
Juniper’s share price change has outpaced Cisco’s and their industry median and average. Juniper’s shares trade at a PE multiple that is twice as much as the S&P 500 and higher than the industry median, whereas its five year sales and net income growth rates are roughly in line with the industry. At 13X, Cisco is selling at a discount to the S&P 500.
We think valuation on an enterprise value basis can be very useful. As we can see, Juniper is valued at 23.5X based on EV/EBITDA. This is above the industry median though less than the industry average. Cisco has an EV/EBITDA multiple of 10.8X. At this level, Cisco is approaching significantly undervalued levels.
After evaluating the drivers behind EV/EBITDA and EV/Sales, we estimate that Juniper the appropriate multiples should be 13.74X and 2.81X, respectively. Our valuation target is $26-$30 per share. For Cisco, we think the appropriate multiple for EV/EBITDA is 11.5X and for EV/Sales, 2.58X. Our valuation target for Cisco is in the range of $18-$22.50.
At current prices, we would not be buyers of Juniper. Cisco is near its 52 week low. We think there is upside potential to buying Cisco now, though we would wait to see how low Cisco goes. If Cisco drops to 8X EV/EBITDA, we would re-evaluate our position. If I owned Cisco today, I would hold it.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
