A Pioneer Is Back in the Game

10/16/2012 8:00 am EST


Rob DeFrancesco

Founder, Tech-Stock Prospector

One of the leading pioneers of the dot.com boom...a company that had the tech to back up the hype, at least for a while...is coming back to teach the whippersnappers a lesson, writes Rob DeFrancesco of Tech Stock Prospector.

Let’s face it, the bloom has been off the Cisco Systems (CSCO) rose for some time now.

The networking leader has morphed into an aging tech behemoth sporting a dividend yield of 2.8%. No one is doling out Cisco as a hot investment tip at hipster tech confabs. The big growth days are over (fiscal 2013 revenue is expected to be up 6%), yet the company could still provide a reasonable total return over time.

These days, Cisco shares—which have rebounded 30% from the July low of $14.96—tend to attract more of the value-investor crowd. For instance, Yacktman Asset Management—a large-cap value specialist with $15.6 billion in long equity assets under management—was among the biggest second-quarter buyers, increasing its Cisco stake by 37% with the purchase of 12.4 million shares.

Wall Street generally respects Cisco and its management team, led by CEO John Chambers, even though it’s acknowledged that the company’s core router and switch units aren’t lighting things up like they did in the past. While Cisco is now a slow grower, I certainly would not put it in the same category as some other big tech names—notably Hewlett-Packard (HPQ) and Dell (DELL)—suffering from significant underlying fundamental problems.

Cisco has become a real tech bellwether, with many investors dialing in to the quarterly conference calls to get a better sense of what is going on worldwide. Chambers certainly can be long-winded on these calls, but he sure provides a complete rundown of demand across the global enterprise, service provider, and government segments.

On the latest earnings call, Chambers gave investors some hope when he said US enterprise orders in fiscal Q4 (ended July) rose 4% year over year, up from 1% growth in fiscal Q3, and that the second half of the quarter looked stronger from a demand perspective compared to the first six weeks. Asia-Pacific/Japan showed impressive order growth of 12%. However, product orders in EMEA were off 6%, dragged down by a 13% decline in the UK and a whopping 24% drop in Italy.

Overall, Cisco’s latest earnings report was fairly upbeat, with revenue of $11.69 billion (up 4.4% year over year) coming in slightly above the consensus estimate. The book-to-bill ratio was above 1 and the company’s product backlog topped $5 billion, vs. $4.5 billion a year ago. Cisco experienced 22% growth in its enterprise wireless segment and 8% growth in security.

One of the most promising areas for Cisco is in the datacenter, where the company has the VCE partnership with EMC (EMC) and VMware (VMW). There have been some doubts about the strength of this joint venture following the latest VMware maneuverings (including the purchase of Nicira), but Oppenheimer & Co. said a recent meeting with Cisco management gave it conviction that the relationship with EMC remains healthy, and that VCE is poised to drive share gains for Cisco in the datacenter.

In fiscal Q4, Cisco’s datacenter orders jumped 58% from a year ago, driven by strong demand for blade servers. The company’s Nexus datacenter switches had a record revenue quarter. At VMworld in August, Cisco and VMware announced an expansion of their partnership to include integrated solutions aimed at enabling the software defined datacenter.

Cisco and VMware will develop UCS-based cloud solutions that bundle various networking offerings (including the Nexus 1000V virtual switch and the CSR 1000V cloud router) with vSphere 5.1 and vCloud Suite 5.1. As part of the announcement, Cisco and VMware said they “remain strongly committed, along with EMC, to the VCE partnership.”

Cisco remains a cash-generating machine. In the latest quarter, the company had cash flow from operations of $3.1 billion. It spent $1.8 billion to repurchase 108 million shares at an average price of $16.62. Cisco is sitting on $48.7 billion in cash and investments (representing 46% of the recent market cap), with $6.2 billion of these funds located in the US

I expect Cisco to continue to use its cash to buy back shares and make smallish acquisitions ($3 billion or less) in key growth segments—including mobility, security, collaboration, and video. The odds are good that Cisco will expand its presence in security, particularly next-generation firewalls. Cisco has its costs under control, so now it needs to look for new growth opportunities.

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