Cisco Systems Inc. (CSCO) announced results for the third quarter that were marginally above expectations but, nevertheless, the price of the stock slid by about 8% on the announcement. This can be attributed to the disappointing earnings forecast for the fourth quarter, concern about global technology spending and apprehensions about the ability of the company to handle prolonged economic weakness. On top of several quarters of disappointing growth, the forecast of revenue growth in the fourth quarter was an increase of between 2% and 5%. This growth would translate into total revenues of between $11.4 billion and $11.8 billion short of the consensus estimate of $12 billion. Estimated earnings per share were between $.44 and $.46 a share short of consensus estimates of $.49 a share. All this has clouded the fact that Cisco has turned in a solid performance for the third quarter based on US demand and gains in the market for switches and routers which offset weak public spending and problems in the eurozone. CEO John Chambers said "We are successfully executing against our long-term strategic plan of growing profit faster than revenue," and described the earnings report as "solid.".
Net earnings at $2.6 billion were up 20%. Total revenues for the third quarter rose by 6.6% from the previous year to $11.59 billion compared to a consensus estimate of $11.58 billion. There was a 5% jump in the core business of network switching. Growth in developed markets was slow the growth in emerging markets including Russia was 12%. Earnings per share were $.48 per share as against a consensus estimate of $.47 per share. Measures taken by the company in the last year to restructure for greater efficiency and focus included streamlining of the organization structure, reducing the head count by 6500 and closing down the Flip video camera business. The best growth prospects for the business continue to be datacenter and wireless, there are signs of progress in the new switching business which accounts for more than 30% of top line revenues.
Though Cisco is the market leader in its line of business, the change in outlook from the last year has been notable. At this time last year, the company was grappling with a number of problems which led to three consecutive quarters of less than impressive performance. Sales were down in contrast to the increase in sales of their major competitors Hewlett Packard (HPQ) and Juniper (JNPR). Cisco is now focused on profitability and has cut spending that is not necessary by $1 billion while becoming leaner and more focused.
I would now like to evaluate Cisco as a potential investment and begin with what many potential investors may consider to be areas of concern. Easily the most discouraging factor is the downbeat outlook for the fourth quarter. It does seem as if this outlook has undergone most of the positives generated by the strong third-quarter performance. The company has reported that customers are taking longer to close deals and are not prepared to commit to spending because of the economic uncertainty. Because Cisco is a manufacturer of expensive equipment that is sold in on a global basis, many observers use them as a reliable indicator of the global economic situation. We should also keep in mind that two of their competitors, Juniper Networks Inc. and Alcatel-Lucent (ALU) have reported declining revenues in their latest quarters.
Let us turn our attention to the positive factors. The first and most important is the financial strength of the company which remains a cash generating machine. It generated more than $3 billion in operating cash flows in the third quarter and has over $48 billion in cash sitting on its balance sheet. The company is not going to go away in a hurry and has the strength to withstand prolonged periods of uncertainty. Cisco believes fundamentally in staying ahead of technology changes often by acquiring other companies who are developing cutting-edge technology. Technology from Cisco supports something like 70% of the Internet and a substantial part of its growth come from the developing markets.
The company continues to pursue acquisitions aggressively in its effort to stay on top of the next leader of computing particularly in the field of intelligent networking and cloud computing. ClearAccess was acquired recently to provide Cisco with the software and the talent to upgrade service management and delivery. It is also acquiring privately held analytics software company Truviso to provide network users with sophisticated analytical capabilities for traffic carried over these networks. An increase in management capabilities as well as access to online information will benefit network users in any kind of business.
Cisco has in the past demonstrated its ability to adapt to change and to tweak its business model to cope. It has outlasted competitors such as Ericsson (ERIC), Alcatel-Lucent (ALU) and Siemens (SI) and I have no doubt that it will continue to do so. Its sheer size and diversity stands out when you consider that one of its major competitors, Juniper Networks, only has about 10% of its revenues. At the current valuation, it is difficult to refrain from recommending a buy on Cisco but I am not committing myself at this point in time. I have no doubt that the company will deal effectively with its present problems but I would like to see some evidence of this as well as an improvement in the fundamentals. I would recommend that if you have an existing investment in the company, hold on to it and watch developments. And if you don't have a position now, use the recent dip as a buying opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.