For a boring company, Cisco Systems Inc. (NASDAQ:CSCO) generates a lot of heat among analysts.
Over half its analysts currently rate the stock a buy, but JPMorgan says CSCO is in a “tough spot,” amid below-average growth and rising interest rates.
Which side is right? Well, both, actually.
Like some other tech companies, such as International Business Machines Corp. (NYSE:IBM), Cisco has been executing a turn this decade from being a growth stock to a yield play. It initiated a dividend in 2011 at six cents per share, but that’s now up to 26 cents, yielding 3.4%.
CSCO shares, while up 71% over the past five years, trail the 85% gain in the S&P 500 during that period. Buying Cisco for growth, in short, has become a bad play, but those who bought it for yield have done well.
The Open Threat
Like Oracle Corporation (NYSE:ORCL), which has been disappointing the Street in recent earnings announcements, Cisco faces a threat from open source. In its case, the threat comes in the form of the Open Compute Project (OCP), originally launched by Facebook Inc (NASDAQ:FB) to reduce the cost of building cloud data centers. Hardware is becoming software, and even specialized pieces of hardware, like switches, are becoming virtual.
Whenever CEO Chuck Robbins addresses the media or analysts, he is asked about the OCP, and his answer is always the same. It’s a threat on the low end, not on the high end; it’s not an either-or but both.
While that answer is accurate, it underestimates the long-term threat. Virtualization is making all sorts of hardware into software. Custom chips and proprietary software may be necessary in some markets, but the industry’s mega-trend is keeping switch margins down, even while formal competition is reduced, and that is not changing.
Cisco is slowly losing its niche.
Seeking New Markets
Aware of the threat, Cisco is seeking leadership in new markets.
Since 2012, Cisco has made dozens of acquisitions in computer security to develop its “Security Everywhere” strategy. Most, like CloudLock, bought in June, focus on the cloud, where Cisco needs to shore up margins against the OCP threat, giving switching customers something to buy while it still has them. Its revenue from security is rising at double-digit rates, even while total revenue remains stable.
Cisco has been continuously developing an Internet of Things strategy, spending $1.4 billion earlier this year on Jasper Technologies for its cloud-based IoT platform. Over time, monitoring products and components will become bigger Internet markets than people, and this is supposed to keep Cisco growing beyond next year.
The problem is that other mainline companies such as Microsoft Corporation (NASDAQ:MSFT) are doing the same thing, and older cybersecurity firms such as Symantec Corporation (NASDAQ:SYMC) are also going “up the stack” with acquisitions aimed at the cloud and other complex systems.
While Cisco’s high-end switches were unique early in this century, briefly making CSCO the most valuable company in the world, the world has since changed. Cisco’s strategy of building secure collaboration with subscription-based software revenue is not unique, and it will have to undergo large layoffs to keep margins up in its core business.
The Bottom Line
Cisco is neither going to collapse nor break out in 2017. Its yield is going to look smaller as interest rates rise. While the dividend remains affordable, usually covered more than twice over by earnings, and a lower stock price would automatically raise that yield, that’s not much of an argument to buy CSCO stock.
Having Cisco in your portfolio won’t burn you, but the company will not burn up the track, either. If you’re looking to speculate, look elsewhere. If you’re looking for yield, buy on a dip.
Dana Blankenhorn is a financial and technology journalist. His latest novel is Bridget O’Flynn vs. Something Big & Ugly. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned shares in MSFT, and FB.
