Have you ever wondered what could topple Cisco (CSCO) from its perch as the world's favorite networking gear maker? Accusations of cyber spying may give Cisco competitors an opportunity to take market share.
Juniper (JNPR), Hewlett Packard (HPQ) and other networking equipment makers have been nibbling away at Cisco's market share for years. A cyber spying row between the United States and China could give Cisco's competitors an opening. If you have not been listening in, here is a quick recap. The cyber spying accusations began flying in October when the House intelligence committee released a report citing potential security threats from Chinese telecom vendors Huawei Technologies and ZDT Corp. The report raised the potential for spy devices to be embedded in equipment and used for government and commercial espionage purposes. Both Chinese vendors deny the accusations. Nonetheless, led by the U.S., sales of Huawei equipment began to decline in some markets.
With a spy backlash against the large Chinese vendors, more North American market share is forecasted to fall to Cisco and its main competitors. Here, the story begins to unfold like an international spy thriller. In what appears to be a retaliatory move, China Unicom (CHU) has blocked Cisco from its Internet backbone network, citing concerns of espionage and 'backdoors' in equipment.
The fallout from the spy charges is still unknown. Will Cisco lose Chinese market share long term? This is not an insignificant question given that China enjoyed a 50% revenue increase in IP/router switch sales in the second quarter of 2012, according to Infonetics Research. With the Chinese vendors falling under suspicion of espionage, will Cisco gain global market share, ex-China? Net-net, how will Cisco fair?
A clearer picture of how the cyber spying row is affecting competitive dynamics will emerge in fourth quarter financial results in 2013. Cisco is already ceding market share to China. Cisco remains the market leader in the enterprise router, ethernet switch and wireless LAN markets, with roughly 73%, 65% and 50% market share respectively. However, over the last year, it has lost a few percentage points in market share across these core businesses, as well as in data center network equipment. Over the same period, China has realized sales growth of 30%-plus in ethernet switches and routers. Meanwhile, Hewlett- Packard has been increasing market share, doubling its router business in 2011, with its largest revenue increases coming from China.
Signs of a slowdown in growth in China could lessen the impact of any spying backlash for Cisco. In the global ethernet switch market, Cisco lost some market share in the second quarter of 2012, according to Infonetics, which reports the ethernet switch market has grown 13% year-over-year to over $5 billion. Yet led by demand for 10 and 40 gigabit ethernet devices, growth continued to be strong in the US market but slowed in China.
Cisco has ceded some market share, but it is hardly struggling. On the contrary, in the fourth quarter, Cisco delivered another consecutive quarter of earnings growth. For the full fiscal year 2012, net sales were up 2012 to $46.1 billion. Net income was up 23.9% to $8 billion. Earnings per share increased 27% to $1.49. At 16.4%, Cisco has maintained a healthy profit margin relative to its competitors. Juniper's profit margin has fallen to 3.8% from 12.4% year-over-year.
Hewlett-Packard's operating margin, at-3.08, is weighed down by its declining PC business.
While Cisco grew earnings at twice revenue growth, its competitors gained top line growth at the expense of earnings. Juniper's revenue was up 1 percent to $1.12 billion from the year-ago period. Net income for the third quarter fell 80% to $16.8 million, down from $83.7 million in the year-ago period. Its operating margin fell to 3.8% from 12.4% a year ago. Higher sales and marketing and research and development expenses reflect Juniper's more competitive but costly posturing. Juniper cited weakness in the Enterprise, security and Asia Pacific regions.
Alcatel-Lucent (ALU) experienced a revenue decline year-over-year of 2.8% to $4.7 billion with a decline of 4.3% to $2.8 billion in the network business. The company posted a loss of $189 million, down from a profit of $251 million a year ago. Alcatel reported a slowdown in its carrier business but its networking equipment business has also seen a weakening in demand. Sales were down in North America, the Asia-Pacific and Europe. One of Alcatel-Lucent's bright spots is its wireless business, which has received a boost with the awarding of a contract to help deploy China Mobile's (CHL) LTE network.
Cisco has a strong technology platform to help it counter any slowdown in business from China. The industry is competing fiercely for lucrative cloud and unified communication services. Cisco is investing to secure its position as a leading supplier of cloud services to service providers and enterprises. Recent announcements include enhancements to its Unified Computing System (UCS), one of the company's most profitable product offerings. Its new UCS central allows IT managers to manage multiple server environments across many enterprises from one place. With help from new acquisitions such as NewScale, Cisco has updated its Intelligent Automation for Cloud (IAC) product to improve management and automation across private, public and hybrid clouds.
Cisco has by no means become a technology laggard. It has just taken the lead market share, at 26%, in the enterprise session border controller market, forecasted to grow to $430 million by 2016, according to Infonetics. With $50 billion in cash and equivalents on hand, Cisco has room to maneuver while the spy intrigue plays out.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.