by Tom Taulli | July 23, 2013 3:21 pm
This year Cisco (CSCO) has gotten some of its mojo back. So far, the gain is about 29%.
This is even more impressive in light of the problems other mega tech operators have faced, such as Oracle (ORCL), IBM (IBM), Qualcomm (QCOM) and Apple (AAPL). They have all posted meager returns for 2013.
In fact, as a sign of the renewed optimism, Cisco has been getting aggressive with its mergers and acquisitions (M&A). Just look at today’s deal for Sourcefire (FIRE), which is a top security software provider. Cisco agreed to shell out a cool $2.7 billion for the company.
OK, perhaps the company is really back on track and will provide continued standout returns for shareholders? Or may this be just another false start? Let’s take a look at the pros and cons:
Scale. Since the mid-1990s, Cisco has remained the clear leader in the data networking space, with about 60% of the market. It helps that the company has continued to invest in its core technologies while buying rivals that threaten its dominance.
Once a company installs Cisco routers and switches, they tend to remain. It’s often too expensive and time-consuming to replace the technology.
As a result, Cisco’s core data networking business is a stable source of cash flows, which allows the company to continue to pursue aggressive acquisitions, pay dividends and buy back shares.
Megatrends. There are two that are big drivers for Cisco.
Cloud: This service allows companies to access business applications from the Internet. So there’s no need for buying hardware, like servers, or hiring expensive consultants. Instead, all the technology is based in data centers. And yes, they are filled with Cisco technologies. Actually, its Nexus switching product line has been getting lots of traction.
Mobile: It’s the holy grail of just about all tech companies. Just listen to the earnings calls from Facebook (FB), Yahoo (YHOO) and Zynga (ZNGA). It seems that the only thing that matters is mobile! As for Cisco, it has built a strong portfolio of technologies that helps to manage the firehose of mobile data.
M&A. This has always been a hallmark of Cisco. The good news is that the dealmaking continues to be spot-on. Some of the recent acquisitions include Ubiquisys (intelligent 3G and LTE small cell technologies), Meraki (cloud-based WiFi systems), Composite Software (next-generation databases) and SolveDirect (cloud services).
The Sourcefire deal also looks like a good one. The company uses open-source software to increase the effectiveness of security, whether on the desktop, mobile device or the cloud. Last year, revenues shot up by 35% to $223.1 million.
But Cisco also realizes it needs to prune its portfolio as well, which means divestures. One was for Linksys. While it is a solid operation, it really did not fit in with the company’s enterprise focus.
Global Economy. It seems to be decelerating. According to the latest report from the IMF, the world’s GDP is forecast to grow by 3.1% in 2013, which is down from the original estimate of 4.1%. The U.S. has turned out to be weaker than expected, but there has also been continued sluggishness in the eurozone as well as problems in China.
While Cisco has bucked the trend, the company could ultimately suffer from the adverse situation (I previously noted how large enterprise tech companies are feeling the pressure). It’s easy for customers to cut back on big-ticket items. Besides, there is a wave of austerity in many countries. And governments are a key source of revenues for Cisco.
Competition. When it comes to the data networking business, Cisco’s scale is likely to keep it the dominant player. Other operators like Hewlett-Packard (HPQ), Juniper (JNPR), and Brocade (BRCD) will probably remain niche operators. Although, in Asian markets Huawei and other Chinese upstarts could be an issue. If anything, they will use deep discounting to snag customers.
Rather, the biggest competitive threats will mostly come from other markets, such as the cloud and mobile. With the strong growth rates, venture capitalists have continued to invest huge amounts in startups. If they create disruptive technologies, it could wind up being a problem for Cisco.
Management. Cisco’s involvement in multiple industries can lead to distractions. After all, the company lost a bundle when it tried to provide consumer-based products.
While Cisco has a top-notch leadership team, there is always the risk that it can get too stretched. This is especially the case when markets are subject to disruptive changes.
Just a few years ago, the prospects looked grim for Cisco. But the company has since gone on to cut back the employee count, divest noncore businesses and to focus on megatrends.
All in all, it’s worked. Growth has returned and the company continues to generate strong operating cash flows, which came to $3.1 billion in the latest quarter. More important, Cisco is targeting some of the world’s biggest growth opportunities.
At the same time, the valuation of the shares is also reasonable, with a forward price-to-earnings ratio of 12 times. There is even a decent dividend yield of 2.6%.
So given all these factors, the pros outweigh the cons on the stock.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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