Cisco, Either Chambers Goes or I Go

Jun.15.11 | About: Cisco Systems, (CSCO)

Cisco (NASDAQ:CSCO) needs to make a decision right now between John Chambers or me. I’m not one to deliver ultimatums, but it has come to the point where either he goes or I go. If you have already made up your mind and think that this article is going to be about me, well you’re right. Because frankly, I don’t think Cisco understands the sacrifices that I have made. I’m this close (imagine thumb and index finger one-fourth of an inch apart) toward ending this relationship if the company does not start reciprocating its loyalty to me as a shareholder. The abuse has to end.

I once subscribed to the idea that “patience is a virtue." And if you are a person like I am who has been practicing such virtuous qualities by holding onto Cisco shares over the past several years, then among your disappointment, you might qualify to write a book about both virtue and frustration. I have become resigned to the fact that my reward for being long Cisco over the years has been neither virtuous nor smart. I keep thinking “this is it ... this is the time they turn things around." But in reality it was a sign of a domestic situation that was destined for lights appearing at your residence at 3 a.m. because the neighbor heard screams. The screams reached higher decibels on Tuesday when the stock dropped below $15 a share for the first time since 2003. Just like any good domestic counselor would have me say, “It was not my fault," though I committed one of the cardinal sins in investing, I had become emotionally attached to the stock.

It has been a love triangle. For almost 15 years, I was committed to Cisco, while the company remained committed to John Chambers. The obvious concern for shareholders recently has been with Cisco’s management, more specifically the CEO. I suspect that I would be hard pressed to find any shareholder today who is willing to state publicly that he should remain as CEO. The common theme is that John Chambers has lost the confidence that he earned in the mid to late 90s when Cisco could do no wrong. The question is what is wrong with Cisco? What is wrong with its products? How can it be fixed? All of these questions are easily answered by replacing John Chambers as CEO. This is now the only option that will keep me as a shareholder through this year. The company has six months.

Start of the Decline

A “technology powerhouse” did not sufficiently describe Cisco in the early to mid 90s. For a brief period of time, the company shot up to the top as the largest tech company in the world by using a tried and true business strategy. It strategically acquired many of its competitors until it owned enough market share to preserve pricing power. It was brilliant. The company figured out a way to combine great products and great relationships with its channel partners. This gave Cisco a distinct advantage over anyone else who sought to enter its space, and then was further helped when the tech bubble ended any growth optimism that existed by the competition that was left standing. Cisco was so effective that it controlled well over 50% of the router market and over 70% of the switch market at its peak. Cisco was generating close to $10 billion annually in cash which then placed John Chambers in that pantheon of leaders who are considered superstar CEOs.

But as with everything in life, Cisco soon learned that nothing lasts forever. When companies began rebuilding data centers and communications networks, Cisco’s competition was provided the opportunity they were waiting for. Through a series of missteps, Cisco became distracted by unnecessary bureaucracy such as when John Chambers replaced Cisco’s top-down decision making with committees of executives from across the company where it created teams to provide strategic advice and evaluate project progress. In total, Cisco at one point had 59 internal standing committees.

At the time, John Chambers justified the structure by saying “it was necessary if Cisco is to keep growing at an impressive rate." I can’t imagine that strategic decisions were made smoothly and swiftly. Another strategic error by Mr. Chambers involved its entry into unattractive consumer businesses. New business lines included camcorders, TVs as well as the UCS, which is the integration of the many different parts of a communications network system. These moves allowed competitors to catch Cisco unaware when they slashed prices on lower cost products.

Overnight, the extraordinary Cisco, for years a global tech-sector bellwether, became just another big company. According to John Chambers, Cisco's main problem is that it had too many great new products. "Our innovation engine is on fire," he told investors. I can only ask, really? If that is the case, I just don’t see it.

The company is suffering from both lack of innovation and shrinking margins. Five years ago it netted 27 cents per dollar of revenue; now it gets a mere 10 cents. What is the incentive for me to stay in this relationship? For almost six years now (and counting), Cisco has failed to give me a reason to not pack my bags and go. In any failed relationship it is natural to point blame. In this case Chambers blamed the governments of Europe and North America for not buying gear as they once had. Again, I ask, really?

Chambers has expanded Cisco into a lot of new failing ventures, but somehow Europe ended up being the culprit.

  • In 2005 Chambers paid $6.9 billion for set-top-box maker Scientific Atlanta, figuring he could combine it with the old Linksys home-router business he'd bought earlier to offer pay-TV service providers a premium product for voice and video. He didn't figure in how fast the home-router market would get saturated or how quickly the set-top box would begin to move inside the guts of connected TVs.
  • In 2009 John Chambers purchased Pure Digital, the company that manufactured the Flip camera, for $600 million. He underestimated the stride that cell phones would make in the video quality of built-in cameras that are always on. Any price for the Flip that was not free became too expensive. We now know Cisco has discontinued that business.
  • An additional blunder was to sell a $600 dollar high-definition home-video communications system called Umi which so far is seen as an expensive hassle compared with Skyping on a laptop webcam.

With all of this, I am now pleading with Cisco to make a decision between John Chambers or me. If you think I am being arrogant, so be it. But I think as a shareholder, I am now more valuable to the company than he is. Cisco has taken me for granted far too long and it needs to decide whether it wants me to put my bags down or tell Chambers to start packing.

In remarkable fashion, shares of J.C. Penney took off on Tuesday when investors became aware that the company was successful in luring away Apple's (NASDAQ:AAPL) retail head to be its new CEO. The stock rose $5.26, or 17.5%, to $35.37 as investors were injected with new life of optimism. It is amazing when I think of what a change in leadership can also do for Cisco’s stock. The relationship has lasted long enough and if Cisco does not end its affair with Chambers, I will have no choice but to serve it with papers in the form of a sells order. The company has six months.

Disclosure: I am long CSCO, AAPL.