Why Cisco Investors Switched Off
The networking giant's growth prospects, at least in the near term, don't
seem capable of supporting the stock's pricey valuation
On Feb. 3, Cisco Systems (CSCO ) reported fiscal second-quarter results that
seem solid. The networking giant boasted $5.4 billion in sales -- 15% growth
over the same quarter a year ago and 6% better than the previous quarter.
Net income was $1.3 billion, or 18 cents a share -- one cent better than
analysts were expecting and up from 15 cents a share a year ago.
Advertisement
Yet in the conference call discussing the quarter's results, Chief Executive
John Chambers was subdued. While the businesses that buy Cisco equipment are
getting a bit more optimistic about the overall economy, he said, they
continue, "perhaps surprisingly," to be cautious about their own capital
spending and hiring plans. In the third fiscal quarter (typically one of
Cisco's weakest), Chambers forecast sales growth of just 1% to 3% vs. the
second quarter.
INSIDE-THE-PARK RESULTS. He went on to explain that Cisco's core switching
and routing products were selling well and that its "advanced technologies"
divisions, which supply equipment for such high-growth markets as storage,
wireless, security, and voice-over-IP (VoIP) networks, were growing briskly
and gaining market share. But in total, "advanced technologies" still made
up just 15% of Cisco's sales in the quarter. For future growth, "GDP will
continue to be the best indicator of what you should expect over the long
run from Cisco," Chambers said.
That was hardly the message that investors were hoping for. Out-of-the park
results posted by networking-equipment providers Juniper Networks (JNPR )
and Nortel Networks (NT ) had raised expectations for a home run from Cisco.
The stock, which had traded up to $29 ahead of the earnings report, dropped
nearly 10% the next day. It has continued to fall, closing on Feb. 17 at $24
25.
The problem at Cisco isn't execution -- although there was unsettling word
of manufacturing snafus and component shortages during the quarter that most
analysts dismiss as a temporary misstep.
"EVEN MORE EXPENSIVE." The real problem is more fundamental -- and tougher
to solve. Investors are beginning to realize that the market for Cisco's
core routers and switches is maturing. Lee Doyle, an analyst who covers
networking equipment for IDC, forecasts that the market for networking
equipment that businesses buy will grow in mid-single digits in 2004 --
about how the economy is expected to perform. That may have been where
Chambers came up with his projection that Cisco would grow roughly as fast
as the overall economy.
Viewed in terms of that unexciting prospect, the stock is getting pricey. "I
thought Cisco was expensive before," says Henry Asher, president of
investment firm Northstar Group in Manhattan. "After listening to the
earnings call, I thought it was even more expensive."
Cisco's price-earnings ratio is now about 34, vs. an average of 18 for
stocks in the S&P 500-stock index. Peter Hofstra, senior investment analyst
at AIC funds, says following its recent decline, the stock is fairly priced.
But he thinks it would have to get below $20 to be a great buy.
LITTLE CHOICE. Cisco's plan for faster growth is to dominate new,
high-growth markets like Wi-Fi and VoIP. The problem there, says Stuart
Phillips, a general partner at U.S. Venture Partners, is that some of those
markets may be only a $400 million to $500 million sales opportunity for
Chambers' company for years. "For Cisco that's a rounding error," he says.
Worse, trying to dominate these markets can require a great deal of
management focus. Even so, Cisco has little choice but to go after them,
since one could "suddenly explode" and become a $4 billion to $5 billion
opportunity, says Phillips.
Meantime, Cisco's core business of selling routers and switches to
businesses is getting tougher. Economic recovery or not, Cisco is
simultaneously facing more pressure from competitors and less-than-roaring
demand for its biggest products, which means profits are harder to come by.
In the recent quarter, Cisco reported a slight decline in gross margins from
68.7% in the first fiscal quarter to 68.5% in the second (year-earlier gross
margins were 70.4%).
"Two or three years of exploiting customers' lack of alternatives is over,"
says Jim Slaby, president of IT consultancy Union Park Research in Boston.
What's more, Cisco's suppliers are enjoying a pickup in orders from other
manufacturers -- and are no longer willing to take the router king's
pressure to keep prices low. "Cisco is getting bitten on both ends," Slaby
adds.
SURPRISE COMING? None of this means Cisco's presence in the networking
business is any less dominating. Indeed, some analysts believe that
investors are being way too quick to write off Cisco. They think Chambers'
cautious remarks are positioning the outfit for a positive surprise in its
fiscal third quarter. "We believe it very likely that Cisco will be able to
exceed the expectations of newly skeptical investors" in its third fiscal
quarter, wrote Sanford Bernstein analyst Paul Sagawa in a Feb. 4 note.
Plus, the recent dip in margins was mostly due to rapid growth at Linksys, a
Cisco unit that sells consumer-oriented Wi-Fi gear. Linksys has margins
closer to 30%, points out Legg Mason analyst Timm Bechter. He continues to
see huge future growth potential for Cisco in the VoIP market. In the second
quarter, Cisco reported weak demand for IP phones -- yet another reason some
investors may have been disappointed with results. But that market is sure
to pick up, predicts Bechter.
That's a long-term perspective worth keeping in mind. But for now, with
Chambers' cautious comments still echoing and the shares carrying a hefty
p-e, lots of market watchers think Cisco doesn't stand out as the kind of
exciting growth opportunity that many tech investors are hankering for.
By Amey Stone in New York, with Olga Kharif in Portland, O
Source: http://www.businessweek.com
seem capable of supporting the stock's pricey valuation
On Feb. 3, Cisco Systems (CSCO ) reported fiscal second-quarter results that
seem solid. The networking giant boasted $5.4 billion in sales -- 15% growth
over the same quarter a year ago and 6% better than the previous quarter.
Net income was $1.3 billion, or 18 cents a share -- one cent better than
analysts were expecting and up from 15 cents a share a year ago.
Advertisement
Yet in the conference call discussing the quarter's results, Chief Executive
John Chambers was subdued. While the businesses that buy Cisco equipment are
getting a bit more optimistic about the overall economy, he said, they
continue, "perhaps surprisingly," to be cautious about their own capital
spending and hiring plans. In the third fiscal quarter (typically one of
Cisco's weakest), Chambers forecast sales growth of just 1% to 3% vs. the
second quarter.
INSIDE-THE-PARK RESULTS. He went on to explain that Cisco's core switching
and routing products were selling well and that its "advanced technologies"
divisions, which supply equipment for such high-growth markets as storage,
wireless, security, and voice-over-IP (VoIP) networks, were growing briskly
and gaining market share. But in total, "advanced technologies" still made
up just 15% of Cisco's sales in the quarter. For future growth, "GDP will
continue to be the best indicator of what you should expect over the long
run from Cisco," Chambers said.
That was hardly the message that investors were hoping for. Out-of-the park
results posted by networking-equipment providers Juniper Networks (JNPR )
and Nortel Networks (NT ) had raised expectations for a home run from Cisco.
The stock, which had traded up to $29 ahead of the earnings report, dropped
nearly 10% the next day. It has continued to fall, closing on Feb. 17 at $24
25.
The problem at Cisco isn't execution -- although there was unsettling word
of manufacturing snafus and component shortages during the quarter that most
analysts dismiss as a temporary misstep.
"EVEN MORE EXPENSIVE." The real problem is more fundamental -- and tougher
to solve. Investors are beginning to realize that the market for Cisco's
core routers and switches is maturing. Lee Doyle, an analyst who covers
networking equipment for IDC, forecasts that the market for networking
equipment that businesses buy will grow in mid-single digits in 2004 --
about how the economy is expected to perform. That may have been where
Chambers came up with his projection that Cisco would grow roughly as fast
as the overall economy.
Viewed in terms of that unexciting prospect, the stock is getting pricey. "I
thought Cisco was expensive before," says Henry Asher, president of
investment firm Northstar Group in Manhattan. "After listening to the
earnings call, I thought it was even more expensive."
Cisco's price-earnings ratio is now about 34, vs. an average of 18 for
stocks in the S&P 500-stock index. Peter Hofstra, senior investment analyst
at AIC funds, says following its recent decline, the stock is fairly priced.
But he thinks it would have to get below $20 to be a great buy.
LITTLE CHOICE. Cisco's plan for faster growth is to dominate new,
high-growth markets like Wi-Fi and VoIP. The problem there, says Stuart
Phillips, a general partner at U.S. Venture Partners, is that some of those
markets may be only a $400 million to $500 million sales opportunity for
Chambers' company for years. "For Cisco that's a rounding error," he says.
Worse, trying to dominate these markets can require a great deal of
management focus. Even so, Cisco has little choice but to go after them,
since one could "suddenly explode" and become a $4 billion to $5 billion
opportunity, says Phillips.
Meantime, Cisco's core business of selling routers and switches to
businesses is getting tougher. Economic recovery or not, Cisco is
simultaneously facing more pressure from competitors and less-than-roaring
demand for its biggest products, which means profits are harder to come by.
In the recent quarter, Cisco reported a slight decline in gross margins from
68.7% in the first fiscal quarter to 68.5% in the second (year-earlier gross
margins were 70.4%).
"Two or three years of exploiting customers' lack of alternatives is over,"
says Jim Slaby, president of IT consultancy Union Park Research in Boston.
What's more, Cisco's suppliers are enjoying a pickup in orders from other
manufacturers -- and are no longer willing to take the router king's
pressure to keep prices low. "Cisco is getting bitten on both ends," Slaby
adds.
SURPRISE COMING? None of this means Cisco's presence in the networking
business is any less dominating. Indeed, some analysts believe that
investors are being way too quick to write off Cisco. They think Chambers'
cautious remarks are positioning the outfit for a positive surprise in its
fiscal third quarter. "We believe it very likely that Cisco will be able to
exceed the expectations of newly skeptical investors" in its third fiscal
quarter, wrote Sanford Bernstein analyst Paul Sagawa in a Feb. 4 note.
Plus, the recent dip in margins was mostly due to rapid growth at Linksys, a
Cisco unit that sells consumer-oriented Wi-Fi gear. Linksys has margins
closer to 30%, points out Legg Mason analyst Timm Bechter. He continues to
see huge future growth potential for Cisco in the VoIP market. In the second
quarter, Cisco reported weak demand for IP phones -- yet another reason some
investors may have been disappointed with results. But that market is sure
to pick up, predicts Bechter.
That's a long-term perspective worth keeping in mind. But for now, with
Chambers' cautious comments still echoing and the shares carrying a hefty
p-e, lots of market watchers think Cisco doesn't stand out as the kind of
exciting growth opportunity that many tech investors are hankering for.
By Amey Stone in New York, with Olga Kharif in Portland, O
Source: http://www.businessweek.com
posted by Rico Biriah at 10:29 am
<< Home