Cisco (CSCO) Moves Into One Of Tech’s Worst Sectors–Servers (VMW)(IBM)(HPQ)(JAVA)(MSFT)

January 19, 2009 by Douglas A. McIntyre

Blue_hillsCheck with Sun (JAVA). The server end of the tech industry has poor margins and unforgiving competition. HP (HPQ) has a server division. It grew only .7% in the company’s last fiscal year, and the operating margins were modest. Revenue for HP as a whole was up 13.5%.

Cisco (CSCO) has decided that it wants a piece of the market where Sun and its competitors have done so poorly and will bring its own hardware to the sector.

According to The New York Times, "The product — a server computer equipped with sophisticated virtualization software — is a bold but risky move by Cisco into an unfamiliar, intensely competitive market that typically produces far lower profits than Cisco makes from network gear."

The vitualization software market also has several strong companies competing for share including Microsoft (MSFT) which is desperate to get into the field, and VMWare (VMW), the current leader. Ironically, virtualization may be the single greatest enemy of the server hardware business. It is designed to allow applications to run across several pieces of hardware and to allow one piece of hardware to run several applications. At their best, virtualization products sharply cut the need for hardware by making software-based software operate more efficiently.

Cisco may have reached the limits of rapid growth in some of its larger businesses, particularly routers. It has done as much or more M&A work over the last five years as any large tech company in the US. The failure of most of those efforts is showing. During the last two years shares in Cisco are off 40%. The stocks of IBM (IBM) and HP are off just a little over 10% during the same time.

Cisco may be succumbing to the temptation of trying to take low-hanging fruit from a market that it believes it can enter because it already has relationships with many of the customers. That it has the relationships is true. But, it is still an awful segment of tech and Cisco getting in will not make that better.

Douglas A. McIntyre