Is Cisco Valuing BroadHop A Broad Hop?

| About: Cisco Systems, (CSCO)

Cisco Systems (NASDAQ:CSCO) became a global leader in communication and IT networking by designing, manufacturing, and selling Internet Protocol based networking products. In mid-2011, Cisco conceded that it had lost its strut and embarked on a transformation. It doubled its four categories of product offerings from Routing, Switching, New Products and Other Products to eight categories of Switching, Next-Generation Network ("NGN") Routing, Collaboration, Service Provider Video, Wireless, Security, Data Center, and Other Products. Cisco's transformed focus is on delivering intelligent networks and technology as well as business architectures built on integrated products, services, and software platforms. Cisco's transformed vision is to be its customer's most strategic business partner. Cisco has evolved from being a box provider to a technology provider to a solutions provider. Being a solutions provider, especially for complex issues, is exactly the pathway to becoming a strategic partner.

Traditional networks built on Cisco routing and switching technologies are being charged with accommodating the demands of increasing numbers of users and network applications. The network platform is also becoming the key factor in new network-related markets such as cloud, mobility, video, BYOD (bring your own device), social networking, and virtualization. Through Cisco's transformation, it is preparing to help its customers transform existing network architecture to an intelligent platform that can provision, integrate and deliver products and services simply, flexibly, quickly and cost-effectively. Cisco believes intelligent networks will be the IT platform that will improve productivity and enable global competitiveness. But, no doubt, intelligent networks are far more than just the latest and greatest development; they are a disruptive cultural shift in the IT world.

Cisco takes pride in its history of recognizing market transitions and driving innovation. Yet Cisco is quick to acknowledge the definition of "intelligent network" is a perplexing one. There is not a "one size fits all" solution. Software-defined networking generates network programmability and moves control from a hardware-centric approach to a virtualized network environment. In an October interview with CIOL, Cisco's senior director of Data Center/Virtualization and Switching spoke about the clarity needed regarding SDN. Interestingly, a true clarity in SDN ends up blurring the lines between hardware and software, between physical and virtual and between network and compute.

At its November, 2012 annual shareholder meeting, Cisco reiterated its five foundational priorities:

  1. leadership in the core business of routing, switching, and services,
  2. virtualization of the data center and cloud computing,
  3. collaboration,
  4. video, and
  5. architectures for business transformation.

Cisco is convinced the network is the principal differentiator of each core facet. Two key market transitions Cisco spotlighted at the annual meeting were

  • the evolution toward more programmable, flexible and virtual networks and
  • the virtualization and cloud-driven enterprise data center being brought about through the convergence of networking, computing, storage, and software technologies.

Cisco's annual report posits its approach to open, programmable, intelligent, virtual networks:

"We believe that integrating multiple network services into and across our products helps our customers reduce their operational complexity, increase their agility and reduce their total cost of network ownership."

"We intend to continue to drive internal innovation, partner for co-development and make strategic investments to lead this evolutional competitiveness."

At the Gartner Data Center Conference on December 12, 2012, senior vice-president Cisco SVP David Yen presented the murkiness around SDN by comparing it to the adage of blind men describing an elephant. Through discussions with customers, Cisco has found that, depending on the customer's business, the programmability requirements are diverse. Research and academia want network slicing. Massive data centers want flow management and deep insight into network traffic. Cloud providers want to allow multiple tenants and automated provisioning. Enterprise data centers want to provide privacy and security as well as virtual workloads. Service providers want agile service delivery through policy-based control, analytics for optimization and the ability to monetize services.

On December 18th, Cisco announced its intention to acquire BroadHop. It may seem curious that Cisco set its sights on a company with just 70 clients. Is that even possibly key? Seriously, is Cisco valuing BroadHop a broad hop?

BroadHop provides policy control and service management solutions for telecom service providers. Its Quantum Network Suite enables providers to take control of their converged networks and their customer relationships. Its open policy platform is the only one designed to support all elements of policy control. It doesn't matter whether the network has new or legacy components, in-network or third-party services, or wired or wireless access technologies. BroadHop, therefore, has developed a vastly-deep and well-proven expertise with mobile, WiMAX, wired broadband, and converged networks.

BroadHop provides the most advanced Policy PCRF product platform in the industry. The PCRF (Policy and Charging Rules Function) software node operates at the network core and plays a central role in next-generation networks. It operates in real time and therefore the PCRF has an increased strategic significance and broader potential role than traditional policy engines. BroadHop is leading the industry into the Policy 2.0 Era - an era where policy solutions are interoperable, are ready to support massive scalability, require little to no professional services and offer a clear ROI for service differentiation.

BroadHop enables service providers to efficiently control, monetize, and personalize any service. A global survey conducted by BroadHop to define its customers' future expectations validated that, for service providers, SDN would make it easier to launch new policy-supported services, would make it easier to handle peak loads, would reduce the cost of policy deployments, and would enable policy to be bought and sold as a service in the cloud. In response, BroadHop confirmed 2013 will be a turning point in the industry as service providers use policy for new service delivery.

Cisco describes the BroadHop acquisition as a "critical piece" and an "evolutionary step in supporting network programmability". Cisco's pledge to its customers perfectly aligns with BroadHop's delivery to its:

Cisco BroadHop
reduce operational complexity efficiently control
increase agility personalize
reduce cost of ownership monetize

So, no, Cisco detecting value in BroadHop isn't a broad hop at all.

Cisco's market cap is ten-fold that of its nearest competitor. Cisco has $45B in cash - more than 4 times the market cap of its nearest competitor. It leads the industry in profit margins at over 17%. Cisco's share price has averaged $18 since mid-2011. Its forward PE of just over 9 is an industry low compared to an industry average of 16.4. If you strip out its cash, the forward PE falls to the 5.25 range.

It doesn't appear the market has yet valued Cisco's transformational progress into its share price. Neither is it granting value to Cisco's leadership in the industry and its ability to lead the industry to an innovative, evolutionary, next generation of intelligent networking. The prospect of Cisco delivering on that vision shouldn't be a broad hop either. Rather, for Cisco, it should simply be a hop, skip and jump.

Disclosure: I am long CSCO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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