Dark Times Ahead For Cisco

| About: Cisco Systems, (CSCO)

Cisco Systems, Inc. (NASDAQ:CSCO) is one of the major producers of networking products and other products related to the IT industry. Cisco has exhibited impressive financial and market performance in the past; however, the same cannot be said about the future of the company. There are a number of factors that indicate that Cisco may face a difficult time in the upcoming financial periods, and these factors are already becoming apparent in the company's market performance.

Factors Influencing Cisco's Market Performance

Cisco's shares fell steeply after around eight months following a downgrade in its rating by FBR. FBR cited that the main reason behind the downgrade was the declining demand for Cisco's components. The share price fell by 3.8 percent to $20.84 and this was the biggest decline for the company since July 24.

According to Scott Thompson, an analyst at FBR, there have been significant innovations in the industry in which Cisco operates, and the demand for switches and routers produced by Cisco is gradually weakening. He said, "Cisco will become increasingly more challenged to offset weaker-than-expected routing and switching demand as it works to transition to a more software and service centric business model." Thus, it can be inferred that Cisco needs to change the nature of its businesses soon and until the transition is completed, the company will continue to witness slow demand and weak financial performance.

FBR changed the rating of Cisco from market perform to underperform, and lowered the price target to $17 from $22. This steep decline in the price target was a major contributing factor in the negative influence on the market performance of the company. The following chart represents the trend of share price over the past 3 months.

The chart shows that there have been several inclines and declines over the past three months; however, the most recent decline is the biggest.

Cisco and Competitors

The slow demand for networking products has not only impacted Cisco, its impacts have been witnessed industry wide. Although Cisco's financial performance has been very positive so far with a profit margin of 25.98% in the fourth quarter of 2012, it can be expected that this performance will decline in the prospective periods.

The major competitors of Cisco are; Alcatel Lucent SA (ALU) and Juniper Networks, Inc. (NYSE:JNPR). The market performance of both competitors is declining as steeply as that of Cisco.

Alcatel Lucent is also engaged in Internet Protocol and optical technologies products and services. The company's market performance has been declining recently. The financial performance has also been unimpressive as the profit margin of Alcatel Lucent for the fourth quarter of 2012 was -35.08%.

Juniper Networks is also engaged in production and selling of networking products. The company received the same treatment from FBR analyst as Cisco. Scott Thompson downgraded the rating for Juniper Networks from market perform to underperform, along with revising down the target price. This change in rating had a negative impact on the market performance of the company. The profit margin of Juniper Networks for the fourth quarter of 2012 was 8.39%.

It can be inferred that the financial performance of Cisco is significantly stronger when compared to competitors. However, if Cisco does not modify its business strategy, the company may witness declining financial performance in the prospective periods. The right thing for Cisco to do will be to diversify the business by focusing on businesses that have rising demand and by expanding its software based businesses. Cisco also needs to be innovative in production of networking products to deal with the declining demand.

After the analysis of the relevant factors, in my opinion, investors should sell their shares of Cisco. I believe that the market performance of the company is declining and the steep decline in the target price of the share will continue to have a negative impact on the share price. Currently, the share price is higher than the target price therefore it may be a feasible decision to sell the shares. Although the company may strengthen its position once it diversifies its business, Cisco will witness a hard time till it achieves that goal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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