Cisco Systems (NASDAQ:CSCO) shareholders cannot get much of a break. After reporting quarterly results, Cisco stock fell from $48.00 to as low as $38.00 recently.
On top of that, it lost a patent infringement case that will cost $1.9 billion.
Despite all the negativity around Cisco stock, why should investors consider this beat-up communications equipment supplier? Several pretty good reasons.
Cisco Stock on Sale
Cisco is a global firm that works in many facets of the networking market. It sells switches, routers, and data center products. Last year, Cisco shares traded at multi-year highs near $60. This is still below the over $77 peak during the infamous dotcom bubble.
Cisco trades at a price-to-earnings that is half of its high-flying peers like Microsoft (NASDAQ:MSFT). Shares also pay a $1.44 dividend, so even though it is down this year, investors get some income.
When the courts ordered it to pay $1.9 billion for infringing on cybersecurity patents, markets ignored the news. Cisco is appealing a ruling that it infringed on four patents that Centripetal Networks owns.
Judge Henry Morgan said, “Cisco did not advance any objectively reasonable defenses at trial.”
The comments suggest that Cisco’s appeal will not succeed, even though the market thinks otherwise.
Investors may build a five-year discounted cash flow EBITDA exit model with the following metrics:
| Metrics | Range | Conclusion |
| Discount Rate | 8.0% – 7.0% | 7.50% |
| Terminal EBITDA Multiple | 10.5x – 12.5x | 11.5x |
| Fair Value | $42.52 – $49.51 | $45.95 |
Furthermore, the model assumes that revenue falls this year and grows as much as 4.7% in the fiscal year 2022:
| (USD in millions) | Input Projections | |||||
| Fiscal Years Ending | 20-Jul | 21-Jul | 22-Jul | 23-Jul | 24-Jul | 25-Jul |
| Revenue | 49,301 | 48,221 | 50,489 | 52,065 | 54,256 | 55,128 |
| % Growth | -5.00% | -2.20% | 4.70% | 3.10% | 4.20% | 1.60% |
| EBITDA | 15,822 | 14,466 | 15,147 | 17,293 | 16,448 | 16,091 |
| % of Revenue | 32.10% | 30.00% | 30.00% | 33.20% | 30.30% | 29.20% |
Note: readers are welcome to change the values by clicking on the link above.
With a fair value of around $46.00, investors looking for a bargain technology stock may buy shares at these levels.
Downside Outlook for Cisco Stock
Cisco shares are on sale for a reason. Although the company posted strong results, it shared downside guidance. In the fourth quarter, revenue fell by 9% to $12.2 billion. It earned 62 cents a share on a GAAP basis (80 cents non-GAAP).
In the first quarter, Cisco expects revenue to fall 9% to 11% year-on-year. EPS will come in the range of 41 cents to 47 cents. So, if readers input a 10% revenue loss every year through to the fiscal year 2025, then Cisco shares are worth $27.37.
In hindsight, Cisco’s WebEx is a lost opportunity. It let Zoom Video Communications (NASDAQ:ZM) offer an easily sharable online meeting experience.
Conversely, Cisco kept its video tool the same. WebEx required a subscription. Its strength of powering online presentations did not match up to Zoom’s free version. This let Zoom meetings proliferate and become a verb. Now, corporations set up a “zoom meeting.”
The lost opportunity for expanding WebEx’s reach reflects Cisco’s low P/E multiples.
Opportunity
Cisco is a slow-moving technology titan that is falling behind young rivals. It could spin-off some of its businesses, just as International Business Machines (NYSE:IBM) announced on Oct. 8. The $19 billion separations of its infrastructure services lifted IBM stock.
If Cisco does something similar, the stock should at least trade back to the $44 – $48 range.
Besides, Cisco could increase its dividend to appeal to income investors. It would need to aggressively buy back shares at current levels to maximize shareholder returns.
In doing so, Cisco’s stock could establish an uptrend again instead of under-performing its peers.
On Oct. 7, the company won a small 5G deal with Verizon Communications (NASDAQ:VZ). It will increase fan safety amid the Covid-19 pandemic by providing mobile edge computing capabilities.
In practical terms, the 5G wideband network will enable crowd density and crowd flow management.
Currently, sports events currently have limited seating, if any. In the future, governments will require physical distancing standards. Both Cisco and Verizon have a workable solution.
Your Takeaway
Technology stocks could stay out of favor for a long time until a catalyst unlocks its value.
Cisco is unlikely to reverse its revenue decline next quarter. So, it will need to reward its patient investors for now, until the under-performing segments rebound.
Disclosure: On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.
