Cisco: Slow Growth Despite Focus On Software
Summary
- We analyzed the company’s main Infrastructure Platforms specifically its switching and routing products which account for the majority of revenues.
- Moreover, we analyzed its Webex and Security segment software as key drivers of growth for the company.
- As the company spends heavily on M&A, we analyzed its acquisitions and determined its revenue contribution of just 0.4% per year.
- We find the company fairly valued at these levels.
raisbeckfoto/iStock Unreleased via Getty Images
In this coverage on Cisco Systems, Inc. (NASDAQ:CSCO), we analyzed its main segment which is its Infrastructure Platforms segment, focusing on network infrastructure systems that have grown slowly in the past 10 years with eroding market leadership in both the switching and routing markets and projected its market share going forward. Moreover, we examine its segments with higher growth, namely its Applications and Security segments where its market share in security appliances had been fairly stable but Webex faces tough competition from Microsoft Teams (MSFT) and Zoom (ZM). As the key growth segments of the company, we forecasted its segments' growth rate contributing to the company's total revenue growth. Lastly, we analyzed its M&A activity supported by its robust FCFs in terms of an estimated revenue contribution and acquisition costs and determined the success of its M&A activities contributing to growth with a forecast of M&A revenue contributions to its total revenues.
Slow Growth in Network Infrastructure Business Segment
Cisco's main segment is its Infrastructure Platforms segment, which accounts for 54% of its total revenues, with an average growth rate of -0.89% in the past 6 years. According to its annual report, the segment consists of networking technologies including switching, routing, wireless and data center products. Switching and routing products represent the majority of the segment's revenues, we estimate it to account for 49% (switching) and 27.7% (routing) of revenues based on its past breakdown in 2017.
IDC
Source: IDC
While Cisco has remained the market leader in the ethernet switch market in the past 9 years, it has been steadily losing market share. On the other hand, the market share of Huawei, Arista (ANET) and others have increased. Huawei share plateaued in 2017 as it previously cited political and economic uncertainties. Arista continued to gain share as it focused on its cloud customers including Microsoft (21.5% of revenue), which is its largest customer, Amazon AWS (AMZN) and Google (GOOG). The switching market is forecasted to grow at a CAGR of 4.07% by Market Research Future.
IDC, Allied Market Research, Khaveen Investments
Source: IDC, Allied Market Research, Khaveen Investments
Company | Market Share | 4-year Revenue Growth |
Cisco | 37.50% | 2.01% |
Huawei | 28.10% | 5.6% |
Juniper (JNPR) | 24.40% | -12.8% |
Average | 24.40% | 0.7% |
Source: IDC, Khaveen Investments
Similarly, Cisco's router market share had declined in the past 6 years. Meanwhile, Huawei and Others gained share while Juniper's share declined sharply as it faced greater competition from new products from Cisco and competition from Alcatel-Lucent according to Trefis.
While Cisco's market share has eroded, it remains the market leader in enterprise network infrastructure with a share of 55.7% in 2021. In its latest earnings briefing, the company highlighted the shift towards the hybrid cloud as a growth catalyst for the company.
We believe the need for highly secure, seamless connectivity, hybrid cloud and hybrid work solutions, along with edge computing will drive growth for Cisco. - Chuck Robbins, Chair and CEO
The company recently unveiled several new networking products including Catalyst 9000x switches and the incorporation of its Silicon One chips in its Catalyst portfolio as well as other technologies including Wi-Fi 6E and private 5G. Previously, in 2021, the company also expanded its Unified Computing System (UCS) server hardware for hybrid cloud services. Thus, we believe these announcements highlight Cisco's commitment to the hybrid cloud.
IDC
Source: IDC
According to IDC, the share of non-cloud deployment was 51.6% in 2019 followed by shared cloud (32.3%) and dedicated cloud (16.1%) but is forecasted to decline to 33.9% by 2025 while shared and dedicated cloud grow to 44.6% and 21.5% respectively. We believe that the shift to hybrid cloud could be beneficial for Cisco's growth with its expanded portfolio. We forecast its market share in the switch and router markets based on its average revenue growth with an additional growth factor of 5.5% based on the forecasted CAGR of the share of the shared cloud deployment type.
IDC, Khaveen Investments
Source: IDC, Khaveen Investments
Company | Market Share | 6-year Average Growth |
Cisco | 45.4% | 0.6% |
Huawei | 10.7% | 3.0% |
Arista | 7.3% | 5.7% |
HPE (HPE) | 5.8% | -1.3% |
Average | 30.8% | 3.2% |
Source: IDC, Khaveen Investments
Based on our forecast of its switching and routing businesses, we projected its infrastructure platforms segment based on our estimated weights for its switching and routing products with the remainder based on Statista's expected market CAGR of the network infrastructure market of 3.87%.
Infrastructure Platforms Segment Forecast ($ mln) | 2021 | 2022F | 2023F | 2024F | 2025F | 2026F |
Estimated Switching % of Revenue ('a') | 49.3% | 49.3% | 49.3% | 49.3% | 49.3% | |
Switching Growth Rate % ('b') | 0.7% | 0.7% | 0.7% | 0.7% | 0.7% | |
Estimated Routing % of Revenue ('c') | 27.7% | 27.7% | 27.7% | 27.7% | 27.7% | |
Routing Growth Rate % ('d') | 2.1% | 2.1% | 2.1% | 2.1% | 2.1% | |
Remaining Infrastructure Revenue % ('e') | 23.0% | 23.0% | 23.0% | 23.0% | 23.0% | |
Network Infrastructure Market CAGR ('f') | 3.9% | 3.9% | 3.9% | 3.9% | 3.9% | |
Infrastructure Platforms Segment Growth ('g') | -0.05% | 1.8% | 1.8% | 1.8% | 1.8% | 1.8% |
Infrastructure Platforms Revenue | 27,109 | 27,600 | 28,100 | 28,609 | 29,128 | 29,655 |
*g = (a x b) + (c x d) + (e x f)
Source: Cisco, Statista, Khaveen Investments
Overall, Cisco is the market leader of both the ethernet switches and router market but has seen its market leadership decline over the past years. We believe the company's portfolio expansion and focus on the hybrid cloud could benefit its growth in the network infrastructure business, but still facing intense competition from smaller players eroding its market share, resulting in our flattish growth outlook for its networking business segment.
Growth From Software Segments
Besides networking infrastructure, the company's other segments include Applications and Security which had been the engine of growth of the company with an average growth rate of 5.45% and 11.69% respectively in the past 6 years.
Cisco
Segments | Revenue Breakdown | 6-year Revenue Growth |
Infrastructure Platforms | 54.4% | -0.89% |
Applications | 11.0% | 5.45% |
Security | 6.8% | 11.69% |
Other | 0.0% | -34.17% |
Services | 27.7% | 3.23% |
Total | 100.0% | 0.93% |
Source: Cisco
For its Applications segment, this includes collaboration products, Application Monitoring and IoT software based on its annual report including Webex. According to Fortune Business Insights, the unified communications and collaboration software market was valued at $47.26 bln in 2021 with a CAGR of 13.5% through 2028. Based on Cisco's segment revenue, this represents a market share of 11.6%. According to YouGov, Cisco Webex is the fifth leading online communications service trailing market leader Zoom and Microsoft Teams at 46% and 29% share respectively. Compared to Cisco, Zoom (504,900) and Teams (650,000) have a larger business customer base than the company at 39,484 customers. Zoom and Teams had an average 2-year revenue growth of 202.8% and 525%.
In 2021, Cisco launched its new WebexOne offering, which added several functionalities and a new phone system that allows users to make calls over the cellular voice network instead of the application. It also acquired Involvio to integrate its student engagement platform with Webex. However, we believe that Teams and Zoom have established a strong market positioning against Webex which could be strong headwinds for Cisco.
Also, the company's other segment involves Security which includes "network security, cloud and email security, identity and access management, advanced threat protection, and unified threat management products" according to its annual report.
IDC
Source: IDC
Based on IDC's security appliance vendor market share, Cisco is one of the leading players only behind Palo Alto Networks. However, the company's market share plateaued in the past 10 years while Palo Alto (PANW) and Fortinet (FTNT) grew rapidly and gained market share.
According to Report Linker, the security appliance market is forecasted to grow at a CAGR of 8.95% through 2026. In 2021, Cisco acquired Kenna Security to integrate its vulnerability management platform with Cisco's SecureX platform to enhance its threat detection capabilities. Moreover, the company also introduced a new enterprise agreement to simplify and streamline its software portfolio for customers.
Where customers and partners previously had to manage multiple EAs, they will now have one purchase agreement spanning Cisco's portfolios. - Leslie Rosenberg, VP, Network Life Cycle and Infrastructure at IDC
We believe that the company's Security segment could continue to grow and project its market share based on its average growth rate.
IDC, Khaveen Investments
Source: IDC, Khaveen Investments
Company | 6-year Average Growth |
Cisco | 12.3% |
Palo Alto | 22.9% |
Fortinet | 19.7% |
Check Point (CHKP) | 3.9% |
Average | 9.4% |
Source: IDC, Khaveen Investments
All in all, as we expect the company's network infrastructure business segment to continue having low growth going forward, we see its Applications and Security segments driving its growth. We forecasted its Applications segment based on its average 6-year growth rate and our projection of its Security market share through 2026.
Segments Forecasts ($ mln) | 2019 | 2020 | 2021 | 2022F | 2023F | 2024F | 2025F | 2026F |
Applications | 5,803 | 5,568 | 5,504 | 5,804 | 6,120 | 6,453 | 6,805 | 7,175 |
Growth % | -4.0% | -1.1% | 5.4% | 5.4% | 5.4% | 5.4% | 5.4% | |
Security | 2,730 | 3,154 | 3,382 | 3,761 | 4,223 | 4,743 | 5,326 | 5,981 |
Growth % | 15.5% | 7.2% | 11.2% | 12.3% | 12.3% | 12.3% | 12.3% |
Source: Cisco, Khaveen Investments
Superb Cash Flow Stability Supports M&A Activity
The company has had an average FCF margin of 24.13% in the past 10 years. Moreover, its capex excluding acquisitions and investments has a 10-year average of only 7.6% of operating cash flows. One of the attributable factors for its lean capex is its business model which relies on third-party contract manufacturers such as Foxconn and Pegatron.
Cisco FCF ($ mln) | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 |
Operating Cash Flow | 11,491 | 12,894 | 12,332 | 12,552 | 13,570 | 13,876 | 13,666 | 15,831 | 15,426 | 15,454 |
Capital Expenditure | -3,815 | -11,768 | -6,643 | -10,088 | -8,117 | -6,036 | 15,318 | 14,837 | 3,500 | -5,285 |
Free Cash Flow Margin (%) | 16.69% | 2.35% | 12.12% | 5.10% | 11.21% | 16.54% | 59.00% | 59.27% | 38.53% | 20.49% |
Source: Cisco, Khaveen Investments
The company deploys its cash for its M&A activities, we complied data of its estimated revenues of its M&A to estimate the revenue contribution to the company in the past 10 years.
Cisco Revenue ($ mln) | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | Average |
Organic Revenue | 48,386 | 47,090 | 49,056 | 49,204 | 47,884 | 48,972 | 51,776 | 49,167 | 49,093 | |
Organic Revenue Growth ('a') | 5.1% | -3.1% | 4.1% | 0.1% | -2.8% | 2.0% | 5.0% | -5.3% | -0.4% | 0.5% |
M&A Revenue ('b') | 220.6 | 52.0 | 104.9 | 43.3 | 121.2 | 358.0 | 127.9 | 133.5 | 725.3 | |
M&A revenue as % of Total Revenue ('c') | 0.5% | 0.1% | 0.2% | 0.1% | 0.3% | 0.7% | 0.2% | 0.3% | 1.5% | 0.4% |
Total Revenue ('d') | 48,607 | 47,142 | 49,161 | 49,247 | 48,005 | 49,330 | 51,904 | 49,301 | 49,818 | |
Total Revenue Growth % ('e') | 5.5% | -3.0% | 4.3% | 0.2% | -2.5% | 2.8% | 5.2% | -5.0% | 1.0% | 0.9% |
*c = b/d
*a = e -c
Source: Cisco, Growjo, Owler, Dun & Bradstreet, GetLatka, Tracxn, Company Data, Khaveen Investments
We derived the company's estimated M&A revenues based on its past acquisitions by year and obtained an average M&A revenue of the total revenue of 0.4%. Subtracting this out from its average total revenue growth of 0.9%, we obtained an organic revenue growth of 0.5%.
Acquisition Costs | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | Average |
Acquisition Costs ('a') | 375 | 6,766 | 2,989 | 326 | 3,161 | 3,324 | 2,979 | 2,175 | 327 | 7,038 | 2946 |
Number of acquisitions ('b') | 6 | 10 | 9 | 6 | 8 | 5 | 7 | 5 | 4 | 7 | 7 |
Cost per Acquisition ('c') | 63 | 677 | 332 | 54 | 395 | 665 | 426 | 435 | 82 | 1005 | 413 |
*c = a/b
Source: Cisco, Khaveen Investments
Based on its acquisition costs in the past 10 years and the number of acquisitions, we derived an average cost per acquisition of the company. Furthermore, we derived an average M&A revenue per acquisition of $23.8 mln. This represents an average revenue as a % of cost of 5.76%. We believe that this indicates its efficient use of capital compared to its average organic revenue growth rate of 0.5%.
Moreover, we projected the company's revenue from M&A activities to be factored in our forecasts for its total revenue by segment. Besides the Infrastructure Platforms, Applications and Security segments we forecasted earlier, we based our forecast for its Services segment on its 6-year average growth.
Cisco Organic Revenue Forecasts ($ mln) | 2020 | 2021 | 2022F | 2023F | 2024F | 2025F | 2026F |
Infrastructure Platforms | 27,122 | 27,109 | 27,600 | 28,100 | 28,609 | 29,128 | 29,655 |
Growth % | -10.2% | 0.0% | 1.8% | 1.8% | 1.8% | 1.8% | 1.8% |
Applications | 5,568 | 5,504 | 5,804 | 6,120 | 6,453 | 6,805 | 7,175 |
Growth % | -4.0% | -1.1% | 5.4% | 5.4% | 5.4% | 5.4% | 5.4% |
Security | 3,154 | 3,382 | 3,761 | 4,223 | 4,743 | 5,326 | 5,981 |
Growth % | 15.5% | 7.2% | 11.2% | 12.3% | 12.3% | 12.3% | 12.3% |
Other | 135 | 19 | 19 | 19 | 19 | 19 | 19 |
Growth % | -52.0% | -85.9% | 0.0% | 0.0% | 0.0% | 0.0% | 0.0% |
Services | 13,323 | 13,804 | 14,250 | 14,710 | 15,185 | 15,675 | 16,181 |
Growth % | 3.3% | 3.6% | 3.2% | 3.2% | 3.2% | 3.2% | 3.2% |
Total | 49,302 | 49,818 | 51,433 | 53,172 | 55,009 | 56,952 | 59,012 |
Growth % | -5.0% | 1.0% | 3.2% | 3.4% | 3.5% | 3.5% | 3.6% |
Source: Cisco, Khaveen Investments
After projecting its revenues by segments, we factored in our forecast for its revenues from M&A. With an average M&A revenue per acquisition of $23.8 mln, we projected its M&A revenue contribution through 2026 based on its average number of acquisitions in the past 10-years to derive the total revenue growth for the company.
Revenue Forecast with M&A ($ mln) | 2019 | 2020 | 2021 | 2022F | 2023F | 2024F | 2025F | 2026F |
Organic Revenue | 51,776 | 49,167 | 49,093 | 51,433 | 53,172 | 55,009 | 56,952 | 59,012 |
M&A Revenue | 127.9 | 133.5 | 725.3 | 193 | 193 | 193 | 193 | 193 |
Total Revenue | 51,904 | 49,301 | 49,818 | 51,627 | 53,365 | 55,202 | 57,146 | 59,205 |
Total Revenue Growth % | 5.2% | -5.0% | 1.0% | 3.6% | 3.4% | 3.4% | 3.5% | 3.6% |
Source: Cisco, Khaveen Investments
Cisco, Khaveen Investments
Source: Cisco, Khaveen Investments
Supported by strong cash flows, we believe that it could sustain its M&A activity going forward, having also factored in acquisition costs in our cash flow projections. Based on our estimates, we derived an average M&A revenue as a % of cost of 5.76%, which we believe indicates an efficient use of capital as its average organic revenue growth rate was only 0.5%. Notwithstanding, we believe its M&A activity did not significantly contribute to its growth which has been flattish in the past 9 years.
Risks: Low Growth and Rising Debt
The company's average revenue growth in the past 5 years is only 0.3% and its 10-year average at 1.5%. Moreover, regarding its profitability, its gross and net margins have only improved from 61% to 64% and 17% to 21.3% in the past 10 years. In its main network infrastructure segment, the company's market leadership is eroding with increased competition from smaller players. We believe this highlights a risk to its growth outlook. Moreover, the company had pursued M&A activity with its strong cash position supported by high FCFs. However, its net debt has risen in the past 10 years as it pursued M&A activity from a net cash position to a net debt position in 2021 at 12.1% of its market cap. Thus, we believe this may hinder its future M&A activity with rising debt levels.
Net Debt (Net Cash) ($ mln) | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 |
Debt | 39,599 | 41,034 | 47,215 | 52,406 | 56,852 | 62,134 | 63,517 | 62,034 | 54,574 | 53,709 |
Cash & Cash Equivalents | 48,716 | 50,610 | 52,074 | 60,438 | 65,767 | 70,492 | 46,548 | 33,413 | 29,425 | 24,527 |
Net Debt (Net Cash) | (9,117) | (9,576) | (4,859) | (8,032) | (8,915) | (8,358) | 16,969 | 28,621 | 25,149 | 29,182 |
Source: Cisco, Khaveen Investments
Valuation
To value the company, we used a DCF valuation as we expect the company to have positive FCFs with an average FCF margin of 19.3% through 2026. For the terminal value, we used an average EV/EBITDA based on selected communications equipment competitors.
Seeking Alpha, Khaveen Investments
Source: Seeking Alpha, Khaveen Investments
Based on a discount rate of 8.9% (company's WACC), our model shows the company is fairly valued.
Khaveen Investments
Source: Khaveen Investments
Verdict
While Cisco has remained the market leader in the switching and routing markets, its market leadership has been eroded by rising competition from key competitors and smaller players. We believe the company could continue to face strong headwinds in these markets but expect its hybrid cloud initiatives to continue some growth to the company. However, we believe its growth could be driven more by the Applications and Security segments with a forecasted growth rate of 5.4% and 12.1% respectively through 2026 higher than its total revenue growth. We believe its Security business could be enhanced by its Kenna Security acquisition but face tough competition against Teams and Zoom for Webex. To counter its slow growth, the company pursued M&A activities which we estimated only contributed 0.4% of revenue growth on average while incurring high acquisition costs. Overall, we find the company fairly valued and rate the company as a Hold with a target price of $52.84.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of CSCO either through stock ownership, options, or other derivatives. 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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