With just a superficial glance, networking giant Cisco Systems, Inc. (NASDAQ:CSCO) appears to be in fine shape. Indeed, I’ve even touted Cisco stock in the recent past, suggesting that if nothing else it could dip into its $67 billion cash hoard and buy its way into a particular market.
The basic premise still stands too — Cisco remains the powerhouse in the router and switching business. Its move into cybersecurity and software-oriented options makes it the name to beat.
If we’re being completely honest though, current and prospective owners of Cisco stock may want to acknowledge a handful of red flags now waving — especially in the shadow of the 30% gain Cisco stock is still sitting on since August of last year.
CSCO is the king of networking. Of that there can be no doubt. Cisco’s kingdom is curiously shrinking though, with its portion of the global Ethernet switching market having fallen from more than 63% in early 2013 to only 53% as of the fourth quarter of 2017.
Fans and followers will counter by arguing the networking market is changing, and raw switch sales aren’t a completely accurate measure of success.
They’re 100% right, too. The future of data routing is software rather than hardware, which blurs the lines more than a little. Increasingly, switching software is able to run on hardware made by various manufacturers, and hardware is able to run different software that effectively routes data. Besides, Cisco is getting into that game as well, acquiescing to business demands created by hungry rivals like Juniper Networks, Inc. (NYSE:JNPR) and Arista Networks Inc (NYSE:ANET). Namely, last week Cisco finally agreed to offer networking software that wasn’t restricted to its hardware.
It’s a wise move, though it may be too little and too late. Would-be customers are already partnering with Cisco’s rivals.
Case in point: Telecom giant AT&T Inc. (NYSE:T) has been working on a so-called “white box” solution for its impending 5G network. It bought thousands and thousands of generic, but flexible, routers that will be powered by software of the carrier’s choice.
The end result? A statement from AT&T explained “Using white box routers and other hardware in our towers and small cells help those types of edge applications smoothly. And it means we can update and upgrade them at the push of a button.”
It leaves one wondering what other boats Cisco may have missed.
Risk to Cisco Stock
The counterargument still remains though: The Cisco of today isn’t the Cisco of yesterday. Chief among those changes is less of a focus on sales of one-time products and a deeper dive into recurring revenue products. Though the margins on “rented” platforms may be slimmer than they are on hardware or conventional licensing, there’s a lot to be said for knowing roughly how much revenue is coming in the door a month from now, and a year from now.
But even that shift may not bolster the bullish case for Cisco stock. As BMO Capital analyst Tim Long pointed out last month:
“Cisco has a clearly articulated vision to generate an increasing percentage of revenue from recurring sources, with a primary focus on growing the percentage of recurring product revenue. Overall, 33% of revenues are now recurring, the majority of which are still derived from the services business. From the product side, the process has been slow and most of the recurring contribution stems from Security, Collaboration, and Wireless LAN. While Cisco’s core switching and routing businesses represent opportunities for further recurring revenue generation, we believe the overall transformation will still take multiple years to play out.”
Long is also concerned that some customers just aren’t into the subscription-based model.
Whatever the case, it’s anything but table-pounding bullishness, and more important, it’s a reality that poses a risk to the value of Cisco stock itself.
Bottom Line for Cisco Stock
Ruined? Not at all. Cisco on a bad day is still a better bet than many other stocks on their best day. CEO Chuck Robbins can and will figure things out before the headwind takes a toll. And for the record, Wall Street loves the company, collectively deeming Cisco stock a “buy.”
Still, inasmuch as Cisco stock is one of the Dow’s best performers of the year so far (up a little more than 7% since the end of 2017), investors — as well as analysts — are clearly expecting big things from the company. It’s an eyebrow-raising optimism simply because the most recent quarter’s revenue was only up 3% year-over-year, and operating income grew just as anemically.
Those aren’t exactly numbers that suggest a company is firing on all cylinders.
It might be wise to reconsider the overly-optimistic expectations. Cisco may well be en route to being the industry’s pace-setter again. But there sure are an awful lot of good questions not being answered in the meantime. The two above are just a sample of several.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
