Tuesday, December 18, 2012

Time to Buy Cisco Systems?

Cisco Systems (NASDAQ: CSCO) allayed the worst fears of the market and the stock got a nice boost. There was nothing really unexpected in these results, but the commentary on enterprise spending was welcome after other tech heavyweights had taken a far more cautionary tone. In summary, Cisco remains a value play and I think the key to its future performance will lie in how it uses its cash flows and balance sheet cash to make acquisitions.

It is an interesting stock, but tech investors usually want growth and value investors usually shy away from tech. I suspect either the market is going to have to change its prejudices or Cisco is going to start getting acquisitions right again before the stock goes meaningfully higher.

Cisco’s Earnings: Macro

It would be disingenuous of me not to mention that I previewed these earnings in an article linked here and earnings came in pretty much as expected. On a top line basis I was looking for around $11.7bn and they came in at $11.9bn but with around $200m contribution from the NDS acquisition within the collaboration segment.

However, the key surprise was in the commentary on the strength of US enterprise spending which grew 9% whilst European enterprise spending was down in the “mid-teens.” This is incongruent with what IBM said a few weeks ago about enterprise conditions weakening in September. Unless the idea is that overall conditions worsened in September only to improve in the US in October?

Cisco is a company known to be relatively exposed to public and developed market spending and has been vocal about warning over a slowdown here so any strength in enterprise will be well received by the company and others. It’s likely to give a fillip to other tech companies. In addition its talk of signs of improvement with US service provider spending is going to set Telco investor’s hearts racing.

Cisco Earnings by Segment

Turning to a segmental view, the core divisions of switching and routing displayed their usual “good cop-bad cop” double act. This time around switching was stronger than expected and routing was weaker, which is a reversal from previous quarters. Routers saw some weakness from Europe with operators switching to faster networks causing a decline in Cisco’s optical networking revenues.

Yearly growth shown here.

The good news here is that the management sounded a lot more upbeat about how it is responding to the competitive threat from Huawei, Juniper Networks, Avaya, and others. These segments are Cisco’s core revenue generators and while its acquisitions in recent years have been questionable and it loses market share in non-core markets it is essential that it continues to perform well here. There are perceived security issues for companies using Chinese hardware and Cisco seems to be benefitting from these fears. While mentioning Juniper it should be noted that a lot of the segments were it competes with Cisco showed strength and I would expect the stock to go up in sympathy.

Service Provider Video results were actually pretty good. The NDS acquisition contributed significantly by underlying revenues were still good. This sort of result will interest those with a position in something like Riverbed or F5 Networks (NASDAQ: FFIV) who both partly depend on service providers spending on application delivery and network optimization solutions. Indeed as outlined here I think F5 maybe being a bit cautious in its outlook. The financial vertical is likely to be cautious until some sort of resolution over Greece and/or the fiscal cliff issue is resolved but AT&T recently affirmed its CapEx guidance and Cisco did say positive things about enterprise spending.

In addition collaboration revenues weren’t as weak as some had expected but with TelePresence described as being down in the mid-teens then this hardly bodes well for its competitor Polycom (NASDAQ: PLCM). The latter has been innovating with new products so it could be grabbing share but overall this just looks like a solution looking for a problem right now. Corporations do not invest in expansionary technology when they see a slow economy.

The last three segments of wireless, security and data center all delivered results pretty much in line with expectations. Data Center spending remains very strong and I think is subject to strong secular growth trends as smart phones, tablets and bandwidth rich internet applications grow exponentially.

Security growth has slowed and this is pretty much in line with a lowering of estimates from companies like Check Point and Fortinet.

Wireless is an ongoing area of strength with bring your own device (BYOD) cited as a key driver. This is good news for Aruba Networks (NASDAQ: ARUN) and with the ongoing diversification of mobile device choices away from the traditional corporate Blackberry solution and towards Iphones and Android based smart phones the outlook does look good here.

Where Next For Cisco?

These results are not a game changer and Cisco still looks to be the low to mid single digit grower that it has been in recent years. It is hardly a growth investors dream. Now I know what you are thinking now and you would be right. I am setting this conclusion up to argue that Cisco is a value play. It generates billions in cash every year and according to Yahoo data it trades on an EV/EBITDA ratio of 4.4 and has nearly $38bn in net cash/instruments on its balance sheet.

Its recent acquisition history hasn’t been glorious but Cisco is a company that was built on timely acquisitions. Given its huge financial firepower it could buy some growth but the market doesn’t seem willing to give it the benefit of the doubt until it demonstrates a return to winning ways. For long term value investors Cisco remains attractive.

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