Naveen Selvaraj's  Instablog

Cisco Systems (Nasdaq:CSCO) released its quarterly results update on Nov 4th but the more important announcement related to Cisco's future as a 'technology leader' came a day earlier.  Cisco announced the formation of a joint venture - Acadia with leading storage vendor, EMC Corporation (NYSE:EMC) and the leader in virtualization technology, VMWare (NYSE: VMW). Clearly Cisco primed the investor community to 'look' at the future rather than the past results. After all, Cisco has always prided itself in having a better reading of tomorrow's technology needs than most other technology leaders.

Behind all the techno-jumbo and marketing speak of this new initative, the intention seems clear. Move from lumpy equipment sales to more steady revenue streams.

"...With the introduction of Vblock TM Infrastructure Packages, the Virtual Computing Environment coalition will provide customers with a fundamentally better approach to streamlining and optimizing IT strategies around private clouds. Vblock Infrastructure Packages are fully integrated, tested, validated, and ready-to-go/ready-to-grow infrastructure packages that combine best-in-class virtualization, networking, computing, storage, security, and management technologies from Cisco, EMC and VMware with end-to-end vendor accountability."

Source: Cisco

A New Initiative, But Just The Beginning

Cisco's new initiative is possibly just the first announcement(my guess) in the serious makeover that John Chambers has in mind for Cisco. The initiative is more a solution to Cisco's own problems that Customer's problems. Customers are not buying network equipment in heaps now and even growth engines like telco roll-outs in emerging markets have slowed down dramatically.

To Cisco's credit, it had foreseen this eventuality of product sales slowing down as early as 2007. Cisco put in $150 M in VMWare as early as July 2007 for a 1.6% stake,  a month or two before VMWare's blockbuster IPO in Sep07. Cisco's bet was that virtualization coupled with more intelligent networks would help customers increase the productivity of their hardware assets- namely the huge data centers and server farms that large corporates had built to accommodate the increasing flow of data. The gamble that Cisco took is that with virtualization, more hardware capex dollars will shift to the networking layer from the data processing(server) later.

If Cisco is hungry for growth( no doubts there, surely!!), the way forward was not just product sales but something more. The Year 2009 probably accelerated this thinking with a double whammy in terms of stunted growth and nowhere to hide(read all products and all geographies are down, down and again down for the last three quarters)

Cisco's Results Show That Customer Capex Spending Is Inching Up Very Slowly

Let's look at Cisco's recent quarter results to understand why Cisco is probably moving faster with this new initiative. Cisco reported a ~13% YOY decline in revenue to ~$9 B. This is the third consecutive double-digit revenue drop for Cisco.

Revenue And Operating Profits

Source: Gridstone Research

I checked Cisco's top-line growth as way back as 2003 and could not spot a YOY revenue decline from 2003 till 2008. Though top-line growth was boosted by multiple acquisitions in these periods, it is an accepted fact that Cisco has grown over the years largely due to such acquisitions.

Third Consecutive  Double-Digit YOY Decline

Source: Gridstone Research

The revenue decline in fact is even worse when we look at product sales alone. Since service revenue has been consistently growing on a YOY basis, the overall revenue decline looks better than the product revenue decline.

Service Revenue Is  Becoming More Significant...

Source: Gridstone Research

And Is Also A More Stable Revenue Stream With Steady YOY Growth

Source: Gridstone Research

What is even more disappointing is that all geographies, except Japan, have seen a YOY decline in revenue contribution. Cisco's much touted growth engine 'Emerging markets' declined 30% YOY. All major  product categories also saw a YOY decline - Routing revenues declined 17% YOY, Switching declined 21% YOY and Advanced Technologies declined 15% YOY.

Though orders in the US have apparently stabilized by being flat on a YOY basis, worldwide orders have declined by 7-9% YOY.  More than 50% of Cisco's revenues come from outside US and so a US recovery alone will not help Cisco in the next 2-3 quarters.

From A Network Builder To A Infrastructure Creator

With a product approach, Cisco restricted its role to consulting customers on network design, product supply and final implementation. Customers typically then went to companies like IBM, Accenture etc to manage large parts of their IT infrastructure. With cloud computing gathering pace(albeit slower than anticipated) and virtualization promising to reduce the spends on server upgrades, Cisco has seized the opportunity to become a more important player in the customer's scheme of things for a future-proof and yet cost-effective IT infrastructure.

Effectively, if customers are unwilling to spend large capex dollars, Cisco is saying that it will build and operate data centers for them and remove the headache of operating and managing the network on a daily basis from the customer and also partake the risk of such capital intensive deployments. In the bargain, Cisco can also fit out such data centers with Cisco's own hardware. This approach would help Cisco move from a lumpy revenue model(which depends on large scale network roll-outs) to a more steady revenue model where Cisco develops, builds and manages important parts of a customer's IT infrastructure.

The Network And Internet Are No Longer Cisco's Only Buzzwords

From the pre-dotcom days, there is no other company which has been as closely associated with the internet as Cisco. As Cisco tries to disassociate itself from a narrow 'networking vendor' image to an 'IT Infrastructure' player, there could well be more changes in the making at Cisco.

One thing which is interesting is how such companies change their taglines and that really conveys a lot about their thinking. Cisco's current tagline is "Welcome to the Human network" which was a huge shift from its earlier tagline of "The worldwide leader in Networking for the Internet". This change was probably because Cisco wanted to develop a more consumer-friendly face and show the world that its networking technologies is not just for corporates but also for consumer's communication needs.

With Cisco's new initiative and focus on being a IT infrastructure player, I was thinking of what could be an apt tagline which could reflect the Cisco of 2010 and beyond. Here's my suggestion:

" Experience Tomorrow's Infrastructure.... Today"

A clean break from the 'Network' and moving to a larger canvass, if I may add!

Disclosure: No Positions