Wednesday, September 12, 2012

Cisco and Polycom are Competing in Tough Markets

In recent months the markets have been selling off enterprise technology stocks as if we were about to enter a dark age of Luddite supremacy where we end up turning to the Amish for advice in how to live in this brave new world. Fortunately, it doesn’t work like that.

However, in a slowdown corporations will change their IT spending habits. They will focus on maintenance spending or critical IT spending. Also, they will mainly want to buy products that have a demonstrable return on investment (ROI) and/or can be easily shown to generate cost efficiencies.

What they will not do is invest in expansionary or discretionary IT spending, which could be seen as an unnecessary expense. I think that video conferencing and unified collaboration is arguably an example of the latter.

Video Conferencing Marketplace

Now I know what you are thinking, but you would wrong. I’m not about to launch into a diatribe on the pointless nature of this technology. On the contrary, I think it has great potential. Globalization is challenging many companies' administrative ability to keep up with the adoption of new regions for sales and manufacturing activity. Moreover companies can use this technology to generate productivity improvements from their staff and manage things like inventory much more efficiently.

That said, the reality is that companies have spent the last few years generating a good part of their earnings growth from productivity improvements via cost savings and avoiding hiring unless completely necessary. They haven’t been splashing out on aggressive expansion. Unfortunately, video conferencing is not seen as a ‘must-have’ technology as it usually implies expansionary spending and it’s also hard to demonstrate productivity improvements with it. In other words, the CIO might ‘get it’ but will he get sign off from the CFO or CEO?

Another reason why CEOs might be reluctant to countenance such expenditures is that cheaper, albeit less practical, solutions abound with things like Microsoft’s $MSFT Skype. When you see global news networks using Skype, it is hard to get too excited about kitting out your global offices with expensive Cisco $CSCO or Polycom $PLCM hardware. Ironically, Microsoft is a partner of Cisco.

In addition the inexorable rise in usage of mobile internet and corporate smart phones means that expenditure is likely to be shifted in the direction of connecting staff via these devices than linking up via meeting rooms.

How is the Market Faring?

According to industry analysts the biggest single player is Cisco with around 50% market share and then comes Polycom with a bit more than half of that.  Other smaller competitors include Logitech $LOGI. I’m going to focus on the top two players.

Here is how revenues are developing for Polycom and for the segment of Cisco (collaboration) that largely contains videoconferencing (telepresence). Note that the last results for Cisco are actually for Q3 but I have adjusted to a calendar year to ease comparisons.

I have labeled Polycom’s revenues because they recently gave results. The last figure of $379m actually beat estimates handily but the next two quarters guidance was a disappointment. Granted the company is divesting its enterprise wireless solutions business so those numbers will drop out comparisons, but the guidance for Q3 revenues of $325-335m and $355-365m for Q4 looks a light. It’s hard not to conclude that revenues are in decline.

Of course, much of this decline is already in the price of Polycom because it is a pure play on the marketplace. In its defense the company is innovating and hoping to release a collection of new products in the second half, which are intended to take market share from Cisco.

As for Cisco, the failing revenue trend raised questions about the efficacy of its purchase of Tandberg Television. It does seem to have been the wrong strategic move. In a similar way perhaps Logitech is regretting its purchase of Mirial?

Where Next?

Frankly, things look tricky. This isn’t a favorable environment for this type of technology. Polycom is doing the right things. Innovation may help it generate future sales growth via grabbing market share and the company is clear that it is gunning for Cisco. It is also divesting a non-core asset. However, competitive and declining end markets usually spell more trouble down the line.

As for Cisco, we will have to see what John Chambers says on the subject in the next result. This is one of Cisco’s largest segments and it’s hard to envisage the company standing buy and losing market share.

Unified collaboration’s day will come but it will be when corporations feel good about expanding discretionary spending. That time isn’t now. Moreover, structural changes in mobile usage and communication may supersede the core demand for video conferencing in future. Investors will have to ride the downturn before things get better and then who is to say Cisco and Polycom will be the winners?

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