Cisco: Looking 15 Years Younger

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

“What you see is what you get.” I am not sure who first coined that phrase, but I have to say that this is not always the case. I mean, how can this be? As humans and investors, we are flawed by nature and filled with insecurities. We are mistake-prone and we are filled with regret. I don’t know anyone who has bought a stock and never regretted the timing. But on a deeper level as it relates to our personal shortcomings, we can easily pretend to be something that we are not and become so good at it that not only are we able to convince others of our façades, but sometimes we even convince ourselves.

Pretending to be something that we are not is one thing. After all, we did it as children, but as adults? That implies another angle -- one that I am not qualified to discuss -- but we can admit sometimes that it is not real. There are many realities in life, but there is no reality greater than what we see when we look in the mirror. What do a company see when it looks in the mirror and does not like what it sees? People can get a make-over if they don’t like their appearances, homes get renovated to bring out the appeal, but what do companies get? They get acquired or they restructure.

At one point, Cisco (NASDAQ:CSCO) was pretending to be a growth company. But it soon realized that it was all a façade when it looked in the mirror and reality kicked in; it was no longer growing. Its growth effectively stalled for several reasons, but most notably because of its bureaucratic structures. In a previous article, I highlighted the beginning of Cisco’s struggles and highlighted in particular how the company became distracted by an unnecessary system of government such as changing its top-down decision making with “committees of executives” from across the company. This created teams to provide strategic advice and evaluate projects. In total, Cisco at one point had 59 of these 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. But that was the problem; Cisco’s growth had already stalled and these committees only exacerbated that lack of growth. Overnight, Cisco, for years a global tech-sector bellwether, became just another big company. Having to deal with poor performance results allowed the likes of F5 Networks (FFIV) and Juniper (JNPR) to catch up in the routing and switching space.

Cisco’s facelift

Looking in the mirror and not liking what it saw, a couple of months ago Cisco decided it was time to restructure and abandon the “committees of executives” way of operating. The company instead reverted to a more conventional top-down structure and in doing so reduced its workforce by 9%. As asked then, would these measures work and were they too drastic? I called these changes “cutting the fat” while also questioning whether Chambers’ legacy would be impulsive layoffs that forced 6,500 people out of a job.

On August 10, Cisco looked 15 years younger after its face-lift as the company reported profits that beat analysts’ estimates. Excluding some costs, profit was 40 cents a share compared to the expected 33 cents. Sales rose 3.3% to $11.2 billion in the period, which ended July 30, compared with an estimate of $10.98 billion. As much criticism that I have given to Chambers, I have to now give the man credit for what appears to be the beginning of a remarkable turnaround in the company. It is clear that the restructuring enacted by the company has strengthened my previous assessment that Cisco is not only great value at current levels but will likely continue to grow in the face of a struggling economy.

How to play Cisco’s results

Astute investors should take notice of the stellar numbers produced by Cisco as there may be some lingering effects. In particular, Hewlett-Packard (HPQ) and Dell (NASDAQ:DELL) are two heavily exposed technology giants that may also have some surprises to announce. Dell will step to the plate first on Tuesday and HP reports on Thursday. Investors of Hewlett-Packard in particular, which is also in the routing and switching business, have to feel pretty good about Cisco’s numbers.

Summary

The toughest thing for me to do even in the midst of its struggles was to ignore its strong fundamental position. If investors look deep into the numbers, they will see a company that trades at a very attractive valuation multiple. It stands solidly with a market cap of $87 billion as well as 58 billion in EV and trades at a modest forward P/E of 8. One can argue that there is no other company that has been able to leverage its balance sheet better than Cisco, which can deliver 40% premium from current valuation by the end of the year.

Disclosure: I am long CSCO.