Cisco Systems Rearranges Itself

Cisco Systems CEO John Chambers, once a hero to tech sector investors, now has serious credibility problems. During the recession, as Cisco struggled along with most other companies, he promissed that investments made during that period would result in a rapid growth of the company post-recession. He repeatedly stated that the growth in data transfers on the Internet, driven largely by the increase in collaboration and video content, would drive a rapid growth in sales of Cisco's routers and switches. In addition, Cisco would enter new areas, "market adjacencies," that would further power revenue and profit growth.

It sounded reasonable. Cisco, led by Chambers, had done it before. It could still happen, but the horizon keeps receding.

Reporting fiscal Q3 (ending April 30) results at the analyst conference call Wednesday, Chambers did not sound as confident as in the past. GAAP EPS of $0.33 was down 11% from year-earlier; non-GAAP EPS of $0.42 was flat y/y. He admitted to problems, but his description of rearanging the management structure of Cisco was not very confincing.

Ethernet switches are a lagging performer. Switch revenue was down 9% from year earlier. That was a year in which the economy expanded, and many companies did very well turning datacenters into "cloud" stuff.

Government ("public sector") purchases were weak. Tax increases, anyone? Without tax revenue, governments are constrained in how much they can buy from companies like Cisco. More money might end up in consumer pockets, but consumers don't by industrial strength 10 gigabyte switches. There is a lot of competition in switches. With Cisco trying to scoop up datacenter server spots from HP, it looks like HP did a better job scooping up switch spots from Cisco. Another example of ruinous competition.

More generally, there are always two tides running at cross currents in the technology sector. If Internet usage doubles, but switch technology improves so that the cost per unit of bandwidth halves, the overall switch manufacturing sector will stand in place. We have certainly seen this with PCs. You just don't need that expensive of a PC anymore to send an email, or even to watch HD video.

I don't own Cisco stock despite following the company for years. I've considered buying, but have always been attracted to companies with lower P/E ratios or higher growth rates. Now might actually be a good time to buy Cisco. Despite its troubles it had $1.8 billion in GAAP net income in the quarter. It had $43.4 billion in cash at the end of the quarter. The stock price is reasonable, if you believe Cisco can continue to compete.

In the past I watched people who buy enterprise switches and routers buy Cisco equipment as the safe, can't get fired for that decision alternative. Now things are more up in the air. Cisco may not be able to get the default victor pricing premium.

Keep it factual for a while, John. Don't be promising investors utopias you can't deliver. Focus on introducing great products, focus on engineering, focus on sales. Even that may not be enough to maintain Cisco's position in this highly competitive neighborhood, but it will do a lot for Cisco's credibility.

For more details on the call, see my Cisco Q3 2011 Analyst Call News Summary.

See also http://www.cisco.com/