The Cisco Systems, Inc. (NASDAQ:CSCO) You Need To Know

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Cisco Systems, Inc. (NASDAQ:CSCO)’s F2Q2016 earnings bested expectations aided in part by improvement in gross margins. Going ahead, superior market position, rich product portfolio and expansion into new growth areas stand out as tailwinds. Nevertheless, weak macroeconomic conditions, unresponsive China market and pricing pressure could disrupt Cisco’s growth and profitability.

How is Cisco prepared to deal with the potential pressures and how well can the company capitalize on its advantages? This Cisco analysis article examines the company’s risks and opportunities to enable you make more informed investment decision regarding the stock. But first, here is a brief flashback of last quarter’s earnings.

F2Q2016 highlight

Cisco Systems, Inc. (NASDAQ:CSCO)’s F2Q2016 EPS of $0.53 comfortably beat the consensus estimate of $0.44. However, revenue of $11.9 billion fell 6% sequentially and 0.1% YoY. A steep decline of the Americas revenue hurt Cisco’s topline in the quarter.

For F3Q2016, Cisco is looking for revenue to increase in the band of 1% to 4%.

 The chart below shows Cisco’s revenue and cost of revenue for the last five quarters:

Capture

What’s exciting about Cisco?

  1. Superior market share in the networking space

Cisco Systems, Inc. (NASDAQ:CSCO) remains the networking equipment provider to beat across multiple product categories despite escalating competition in the networking space. With the leading market share, Cisco stands to take greater advantage of the anticipated growth in Ethernet switching, data center and other networking-themed markets.

The global market of Ethernet switches rose 32% sequentially in the December quarter and 14% from a similar quarter a year earlier. Strong growth was also registered in data center market. More growth is expected in these markets in the coming years.

    2.Sharp innovative edge

Cisco came up with a simplified server system called Unified Computing System (UCS), which it is currently in the process of popularizing. It is working with a host of partners including Microsoft Corporation (NASDAQ:MSFT), Intel Corporation (NASDAQ:INTC) and Oracle Corporation (NYSE:ORCL) among others to popularize UCS and the system is winning customer interest.

Cisco’s UCS is a transformative server technology that is particularly drawing interest because of its cost advantages. The system significantly lowers the cost of data center ownership. It is also favored for its flexibility and scalability features.

    3.Focus on cellular carrier market

Cisco Systems, Inc. (NASDAQ:CSCO) has identified growth opportunity in the wireless network management market and it is leaving nothing to chance to go for it. The company has recently completed a string of acquisitions that are no doubt targeted at boosting its play in the wireless carrier market.

Because of the explosion of smartphones and the desire by carriers to improve network quality and efficiency, demand is growing for solutions the help to manage traffic efficiently. That explains why Cisco has been aggressive in acquiring strategic assets in networking management space.

The other reason the company has increased focus on the wireless network market is that it is hoping to open growth opportunities for its security and services business. Cisco is in the process of diversifying its revenue streams away from hardware sales, which are prone to market cyclicality. Software and services business is more stable because revenues are subscription based, thus recurring.

    4.Focus on integrated security strategy

Cisco is doubling down its efforts in the security market at a time when spending is expected to increase in security solutions as security threats evolve rapidly. To bolster its play in the security space, Cisco is acquiring strategic assets. The acquisition of Sourcefire reduced competition for Cisco in the security market and it is now helping it to expand its market share.

The various security-themed acquisitions that Cisco has made in the recent times are also helping it to increase exposure to lucrative corporate and government markets. Additionally, the acquired assets are helping to augment Cisco’s security solutions, thus allowing the company to accelerate expansion in integrated security market. There is a growing trend in which enterprises are tilting their security spending toward integrated security products to enable them lower administrative costs. Cisco has noticed the trend and it is doubling down its efforts to roll out integrated security solutions that offer continuous detection, protection and remediation of security threats.

The global market for security and services is projected to grow to $86 billion in 2016. That’s a huge market opportunity for Cisco to target with its integrated security products.

     5.Pushing back against SDN

Cisco Systems, Inc. (NASDAQ:CSCO)’s hardware business has been hurt by software defined network (SDN), but the company is not taking the threats lying down. To push back against SDN, Cisco is exploiting the weaknesses of SDN and has come up with a networking solution called Application Centric Infrastructure (ACI). Despite its long name, ACI helps to streamline networking infrastructure and also comes with cost advantages. For example, ACI saves on cabling, power, cooling and other operating expenses. Cisco says the cost of owning an ACI-based system is 75% lower than the cost of owning a SDN system. Cisco’s ACI is built into its Nexus 9000 portfolio of switches.

Going by Nexus 9000 switches sold in F2Q2016, there is no double Cisco’s ACI-based networking solutions are appealing to customers. The networking market is poised for massive growth in the coming years thanks to the rise of cloud computing.

What’s worrying about Cisco?

  1. Integration risks

To uphold its market share in key markets, accelerate growth and expand into new markets, Cisco has turned to strategic acquisitions. However, acquisitions come with their challenges – integration risks. Sometimes it takes time to successfully integrate an asset, which can attract more costs and delay the realization of the expected benefits. Additionally, integrations also tend to distract the management from core issues, especially where culture integration is also involved.

     2.Shrinking Chinese market

Cisco Systems, Inc. (NASDAQ:CSCO) reported in F2Q2016 that orders in China fell 19%, indicating continued pressured for the company in the world’s second-largest economy. Trouble for Cisco in China escalated in the aftermath of the NSA surveillance scandal exposed by Edward Snowden. In the wake of the spying claims, Chinese corporations have tended to buy networking equipment from domestic providers especially for sensitive industries such as finance. The move has made growth in China increasingly difficult for the Cisco. As such, the company is shedding market share to rivals Huawei and ZTE.

     3.Intense competition in core business

Cisco is facing competition from almost all directions, but competition in its core routing and switching market is the most worrying. Competitors are improving their products to match Cisco’s quality and they are undercutting the company with competitive pricing strategies. Competitive pressure has particularly been growing more intense in Cisco’s core business of selling routers and related support.

To try and fend off the competition, Cisco has resorted to enticing customers with steep discounts, which are ultimately eating into margins and thus earnings.

    4.Forex risk

Cisco Systems, Inc. (NASDAQ:CSCO)’s massive international footprint exposes it to adverse foreign exchange fluctuations, which are dimming international revenue growth.

Capital deployment

Cisco Systems, Inc. (NASDAQ:CSCO) finished F2Q2016 with cash and short-term investments amounting to $59.1 billion, indicating good liquidity position. With such flexible balance sheet, Cisco can afford to make more strategic acquisitions to bolster its plays in various markets it is targeting for growth. Addition, the healthy balance sheet means that the company can afford to return more value to shareholders.

Cisco returns value to its shareholders through a combination of shares repurchases and dividends. The company recently announced sweetening of quarterly dividends by 5 cents to $0.26 per share. Buyback program was also raised so that Cisco will now repurchase shares worth about $16.9 billion.

Takeaway

Unresponsive China, SDN penetration and price-based competition remain as headwinds for Cisco Systems, Inc. (NASDAQ:CSCO) to confront. However, the solid balance sheet, commitment to innovation and appetite for growth in new markets could help Cisco not only uphold its market share, but also grow it.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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