Cisco's Message to Wall Street: Stay here, I'll be back

Once upon a time, Cisco Systems, Inc. (NASDAQ:CSCO) founders Ben Bosack and Sandy Lerner wanted to email each other from their respective offices located in different buildings at Stanford University but were unable to due to technological shortcomings. A technology had to be invented to deal with disparate local area protocols; and as a result of solving their challenge – the multi-protocol router came to life.

Cisco was founded the same year Facebook founder Mark Zuckerberg was born and the future Governor of California starred in ‘The Terminator‘ – it was 1984. The company has since grown to more than 72,000 employees worldwide and in their latest quarter they raked in $10.41 billion in revenue. However Wall Street has fallen out of love with Cisco. Since Feb 9th its stock has dropped 14% and hit a new 52-week low of $18.56 this past week. Cisco shares have lost 40% since November 2007 and its down 21% in the last 12 months while the Nasdaq has rallied 30%. Depsite a profit of $1.52 billion in Cisco Systems’ latest quarter and revenue climbing 6%, its not enough to keep the analysts happy thus down we go.

CISCO TERMINATED AGAIN
Cisco shares have lost 14% since its latest earnings call on Feb 9th, the same thing happened to the company back in November when they disappointed the Street and by December the stock was down 20%. However, the bottom feeders started buying up Cisco and the stock went from $19 back up to $22, and now its trading under $18. The six month chart is not pretty and Cisco’s new 52-week low can be attributed to the company’s warning of slower revenue growth along with the CFO Frank Calderoni’s statement last week of “bear with us” for the next two quarters as the company works through its product transition.

Traders and investors aren’t willing to “buy and hold” these days. That mentality died in 2008 when the market crashed. However to throw Cisco Systems away as a company that will never really do anything again, like Microsoft (NASDAQ: MSFT) is premature. After all, its not like Cisco is pulling a Microsoft / Nokia Windows Phone 7 venture that is almost as desperate as Schwarzenegger appearance in 2003’s Terminator 3: Rise of the Machines. When companies don’t exceed analyst expectations we are all quick to hit the “sell” button, forget that Cisco has almost $40 billion in cash, they will never get their footing back.

Come on, that’s enough cash to bring the T-1000 or T3 to life, but that’s not Cisco’s game. Cisco all but started the VoIP market, they are the largest vendor of the equipment that connects businesses, individuals, governments and phone carriers to each other. However Cisco has tough competition and it’s their mix of new and existing products that is taking its toll on the 27 year-old company. Jon D. Markman at MoneyMorning.com described it best last week:

Yet the elephant in the room is the fact that competitive pressures are forcing Cisco to move customers to new products more quickly than it intended, according to research analysts for Signal Hill Capital LLC. Channel checks suggest that sales of the company’s largest switching platform, the Catalyst 6500, slowed at the end of 2010 as the product rapidly become uncompetitive from a price and functionality perspective.

Responding to this trouble like a SWAT team, Cisco did finally migrate customers to its hot new product lines, the Nexus switch family and the ASR routers family. Both of thesearemore competitive– but at much lower margin. As a result, the analysts say that the Nexus family of switches are growing more than 100% year over year and the ASR family of routers are growing more than 68% year over year, but they are cannibalizing legacy products.

Management indicated they have increased the gross margin on the Nexus product line by 800 basis points over the past several quarters, but the margins are still significantly below the company’s average, let alone the lofty margins of the Catalyst switches. … This is not a problem that can be fixed in three months.

I’LL BE BACK

As a value investor, I couldn’t resist picking up a few shares of Cisco (CSCO) when it was in the $18.60 range. The company is now under tremendous pressure to turn things around and if their management can’t get it together in the next few months, expect a shuffle in operations. Cisco’s CEO John Chambers has helped grow the company from $70 million when he joined in January 1991, to $1.2 billion when he assumed the role of CEO, to its current run rate of $40 billion. In 2006, Chambers was named Chairman of the Board, in addition to his CEO role. If Cisco’s stock price doesn’t start heading higher in the next six months, the board may say Hasta la vista, baby to CFO Frank “Bear with Us” Calderoni and CEO John Chambers.

The downgrades from analysts have been steady on Cisco since Feb 9th resulting in lower price targets: Piper Jaffray says $21, Deutsche Bank at $20, Barclays Capital and Citigroup lowered to $22, and Auriga U.S.A at $23. All of the downgrades are justified. How can Cisco achieve its longer-term growth forecast of 12% to 17% annual revenue growth? Why is it not doing as good as it rivals? Juniper Networks Inc. just increased sales 26% and last month EMC Corp. and IBM also posted record quarterly revenue and profits, yet Cisco’s proft fell 18%.

The demand for Cisco’s products and services are ever-present, this isn’t a case of fading MS Windows technology, we are expanding into the “cloud” and their expertise is ideal for future growth and revenue. Cisco has the opportunity to grow, thanks to the world acquiring the appetite for technology, some of the latest projections:
– Global file sharing traffic is projected to reach 11 exabytes per month in 2014, 22 percent CAGR from 2009-2014.
– Global business IP Traffic is forecast to reach 7.7 exabytes per month in 2014, more than tripling from 2009-2014.
– Global mobile data traffic will increase 39 times from 2009 to 2014.

Bottom line: Cisco Systems has everything going for them to be the comeback kid in 2011. The question is can they do it, and when will Wall Street begin to believe them?

Frank Lara Jr

The author has a long position in CSCO.