Wednesday, February 13, 2013

Cisco Earnings Analysis

In general it’s been a better than expected earnings season for technology. Sure there have been some disappointments with cautious enterprise spending and Government cutbacks, but we haven't seen any major IT stock say that the macro conditions are noticeably getting worse. All of which leads us into Cisco System’s (NASDAQ: CSCO) results for Q2. I want to preview them so investors can quickly know what to expect.

Cisco Earnings Analysis

It’s fascinating to look at Cisco because its constituent parts cover so many areas of technology investing. Not only is the stock worth looking at in itself (although primarily as a value play), but what it says about the tech market is important too.
My take on the backdrop:
  • There is evidence to suggest that Telco spending will be stronger in 2013, and Cisco could be a key beneficiary.
  • Enterprise spending remains cautious, but most companies have reported stabilization.
  • Anecdotal evidence from the earnings of some of Cisco’s rivals in certain segments suggests that Cisco is losing market share in areas like security, collaboration and wireless.
With these points in mind I’m biased to expect some relatively better numbers in Cisco’s core activities of switching and routing but not such good news from its more peripheral activities. It probably needs to have a think about making some acquisitions in the periphery, but it is presented with difficulties in many of these markets because of anti-competitive issues.

Previewing Cisco’s Earnings

A quick look at Cisco’s revenue split in the last quarter demonstrates that the core activities of Services, Switching and Routing make up around 70% of revenues and are what really guides the company.

Continuing the theme of stability in Cisco’s core activities I want to look at the core in isolation first.

Services, Switching and Routers

There is no doubt that the second half of last year proved to be tougher in terms of IT spending than many had hoped it would have been going into 2012. Moreover Tier 1 carrier spending slowed down as the year went on but there are real signs of a pick -in spending from the likes of Sprint Nextel and AT & T. This should start feeding through into Cisco’s switching and routing revenues while its services revenues tend to be pretty consistent.

Switching and Routing revenues tend to decline sequentially going into Q2, and I expect the same again for 2013. Moreover, it is up against some tough comparisons last year.  Therefore combining these three elements together I would expect yearly declines in routing and switching (low single digit declines) plus an 11-12% gain in services. As a rough ball park figure this would make around $8.1bn for Cisco’s core activities.

Collaboration and SP Video

Collaboration is an area where Cisco has had some difficulties over the last year. Frankly it’s been a tricky market, as things like telepresence, call center and unified communications are activities tailored towards corporate expansionary spending. In other words when companies cut back it is precisely in these areas that the first cuts will be made.

On the other hand, Cisco’s key rival in collaboration Polycom (NASDAQ: PLCM) has reported better numbers of late, with a 5% sequential increase in revenues in the last results. Cisco’s collaboration earnings tend to mimic its rival. However, the question is whether Polycom’s efforts to release new products and differentiate itself from Cisco has worked or, whether its results are just a function of an improving market? We are about to find out.

Yearly revenue growth for Collaboration and SP Video.

Before anyone gets too excited about SP Video, I should note that Cisco got a $200 million contribution from the acquisition of NDS in the last quarter. Putting these two divisions together I would expect combined revenue of around $2.3bn with a positive comparison for collaboration.

Wireless, Security and Data Center

Investors in Aruba Networks (NASDAQ: ARUN) should keep a close eye on what Cisco says about its wireless revenues and particularly Bring Your Own Device (BYOD) spending. Thus far, all the evidence is pointing to a very strong set of results. Companies as diverse as Fortinet (NASDAQ: FTNT) and F5 Networks have been reporting strong interest in mobility and BYOD solutions. On a related note, I don’t think the Blackberry 10 is going to bring back the heyday of the company and mark a shift away from the necessity of BYOD. In fact it may increase BYOD demand. I expect Aruba to report good numbers.

Within security, most of the leading players have reported. Check Point is going through its application platform refresh and seems to be playing a waiting game before demand catches up with its new technology. Fortinet’s results were excellent, but the company did cite a number of wins from Cisco (particularly in firewalls) in its conference call, and there is a sense that its solutions are becoming viable to larger enterprises. I think Cisco is falling behind in security and wouldn’t be surprised to see it make an acquisition in the sector. Fortinet?

Lastly with Data Center, I am going to stick my neck out and offer a note of caution. Yes the results will signify very strong growth but it might not be quite as strong as the market thinks in future.  Data Center companies like Equinix (NASDAQ: EQIX), Telecity, and Digital Realty have all been aggressively increasing capacity over the last couple of years and any company selling data center infrastructure has seen the fruits of this. However I note that Equinix is planning to reduce CapEx in 2013 and I suspect the industry could see a shift in the mix towards relatively higher maintenance spending. Look out for the guidance on data center spending.

My back of envelope calculations suggest $1.3-1.4 billion in combined revenues for these segments and don’t be surprised to see security growth slip to mid single digits.

Is Cisco A Stock to Buy?

Putting these numbers together and including $200 million in ‘other’ revenues gives a ball park figure of around $12 million in revenues. The exact number doesn’t matter so much as what Cisco reports and says within its individual segments. For the company as a whole the key marginals will be the switching and routing divisions so keep an eye on those.

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