It is not often that misreported news creates a dangerously inaccurate investment thesis such that one must speak up, but various stories surrounding the future of Cisco Systems Inc. (CSCO) is just such a case. First, several articles appeared that suggested that Cisco's decision to increase its dividend by 75% was a sign that the company had accepted the "reality" that it was no longer a growth stock. Despite some very growth-oriented characteristics, there is some merit to the idea that by paying a more sizeable dividend, the company is accepting that it also has matured in certain areas. A recent article, however, suggests that VMware Inc. (VMW) has put "a target" on Cisco; given the expanded strategic partnership announced by the two companies recently, the target concept misses the mark. Cisco is embracing the changes that face the networking marketplace while still capitalizes on those areas in which it is dominant. For these reasons, Cisco is a buy a current levels.
The Cisco/ VMware Strategic Alliance
The strategic alliance between Cisco and VMware has been in place for some time, but the recent announcement deepened the connection between the two firms. The primary purpose of the partnership is to allow each member to commit investment dollars to the creation of an integrated division. The division will hire a completely new and independent engineering team that will focus on the software defined data center. Ironically, the power of the software defined data center was cited as one of the central weapons being used by VMware to hunt Cisco. The newly formed team will work at merging VM's cloud solutions with Cisco's networking might.
In case there is any remaining doubt, VM's new CEO was quoted when the announcement was made, praising the importance of the collaboration:
The software-defined datacenter will deliver the next leap in software-based datacenter automation across server, storage and networking, but it requires equal hardware and systems-based innovation. We are very excited to further our partnership with Cisco, the industry-leading innovator in networking, as we believe it will bring significant value to our joint customers through the integration of the VMware cloud infrastructure platform with Cisco's intelligent network fabric.
The creation of such a fully-integrated project across company lines in uncommon and speaks to the belief of each company in the importance of the products that should result. The software defined datacenter represents a significant growth opportunity for both companies.
If Cisco's dividend is not an admission that it is no longer a growth company, one is led to ask what it signals to investors. If one can accept that Cisco continues to have avenues for significant growth, the increase in the dividend and statement that the company will target the return of 50% of free cash flows (FCF) to investors should be viewed as the company showing its ability to adapt to the investing landscape, just as it does to the technology landscape. During a period in which U.S. Treasuries yield an anemic sub-2%, the inclusion of a near 3% dividend makes Cisco even more attractive. The company's most recent earnings report left investors somewhat uneasy as the numbers were not as strong as might have been hoped. Still on a valuation basis, Cisco looks strong. The company has a P/E of 12.8 relative to 36.4 for Juniper Networks (JNPR), negative earnings for Hewlett-Packard (HPQ) and an industry average of 20.8. The networking space has become increasingly competitive, but the continued growth in the volume and importance of Wi-Fi networks has driven business with the sector.
Despite some erroneous opinions - and facts - Cisco continues to be a growth story whose expanding partnership with VMware should pay significant results over time. Rather than being a reason to reclassify the company, Cisco's dividend adds to its attractiveness. Overall, Cisco is a buy at current levels and should be a part of every investor's core portfolio.