This week, Cisco (Nasdaq:CSCO) CEO John Chambers, emailed a memo to his employees and was quite frank. He mentioned how the company has not been able to make “bold changes” and has “lost the accountability that has been a hallmark of [its] ability to execute consistently.”
Shareholders can certainly understand. Over the past five years, the stock price has sustained an annual rate of return of -4.44%. In fact, the shares have gone down about one-third in the past 12 months.
So far, the response to Chambers’ letter has been encouraging. The stock price spiked nearly 5% before a pullback of about 1% on Thursday.
But is this a relief rally or the start of something real? Here’s a look at the pros and cons.
Pros
Must-have products. Cisco makes technology that is at the foundation of the Internet and other communications. The main offerings include routers and switches, which are highly sophisticated technologies. At the same time, it’s expensive and even risky for customers to move to other vendors. Thus, the customer lock-in is significant. Cisco still commands 70% of the market and gets juicy margins.
Cheap valuation. All in all, Cisco looks like a deep value play. The price-earnings ratio is a measly 13. And, if you subtract the $40 billion in cash from the balance sheet, the multiple is only 8.
Spinoffs. For two decades, Cisco has been an M&A machine. It has been a way to dominate markets and increase innovation. However, some of these deals have not performed well, especially in those segments that are far removed from the core business. This appears to be the case with the consumer division, which includes products like the Flip camera and the Linksys offerings. They have small margins and stiff competition. In other words, Cisco has an opportunity to spin off these assets and improve its focus.
Cons
Slow moving. The layers of management and corporate structure look like a 1980s Soviet system. Keep in mind that Cisco has 59 internal committees. With such complexity, how can this keep the company on the cutting edge? As a result, Cisco has seen various high-level executive departures, such as its chief marketing officer, Susan Bostrom. Perhaps the person who should depart is Chambers. While he led the company through its massive growth spurt in the 1990s, his managerial skills have proved lacking. In fact, there is buzz that activist shareholders may stage a proxy fight to shake-up the senior management.
Competition. It is amazing that Cisco has maintained its lead in the switching and router business. But nothing lasts forever. The fact is that smaller players — like Juniper Networks (Nasdaq:JNPR), Huawei and Acme Packet (Nasdaq:APKT) — are making inroads into the business.
No takeover value. Cisco has a market cap of roughly $100 billion. This means it would be nearly impossible for a leveraged buyout or an acquisition from another company.
Verdict
True, Cisco has a dirt-cheap valuation. The problem is that a stock can remain at such levels for a long time. Just look at other tech laggards like Microsoft (Nasdaq:MSFT) and Intel (Nasdaq:INTC).
Essentially, Cisco needs to give a reason for investors to get excited. Unfortunately, the company has waited too long to take action. To restructure things, there will need to be many tough decisions — which will involve spinoffs, cost cuts and the elimination of various businesses. Yet Chambers’ letter was fuzzy about the strategy.
In addition, the core switching and router business is fairly mature and will not provide the kind of growth investors are looking for. Adding things up, it looks like the cons outweigh the pros on the stock.
Tom Taulli’s latest book is “All About Short Selling.” His Twitter account is @ttaulli. He does not own a position in any of the stocks named here.
