We are going to be tough on our competitors, whether they’re Juniper (JNPR) or HP (HPQ),” Chambers said on the conference call. “It’s something I think we were a little too gentle on in the past. We are going to lead in the switching market.”
- Cisco (CSCO) CEO, John Chambers
I don’t know who coined the phrase “those sound like fighting words,” but I suspect the quote above by Cisco CEO John Chambers would more than likely fit the criteria. I said on Wednesday (anticipating its conference call) that Cisco would announce its presence with authority. But I had no idea that it would include what I now perceive to be a “bounty” on the competition. It’s been a while since I saw this shrewd side of Cisco and as a shareholder I wouldn’t want it any other way. Because it was precisely that attitude that once propelled the stock over $100 per share in the late 90s.
What has been clear to me for quite some time is now becoming more evident to the rest of the market. Cisco is once again regaining its standing as a Wall Street darling, but this time it’s taking no prisoners. I hope you don’t mind the confident tone in this article. It’s just like wearing your favorite team’s jersey for an entire week after they win the Super Bowl - certain successes tend to have this sort of psychological impact, particularly when one has been as emotionally attached to Cisco as I have been. I admit, it’s a cardinal sin and it has been my fault, but I’ve now gotten it fixed.
The quarter that was
On Wednesday, Cisco reported its Q1 fiscal 2012 results. I’m not sure if there is another way to describe it other than remarkable. “Remarkable” is appreciating where the company was just a short 6 months ago when I called for the firing of John Chambers.
Excluding some costs, profit climbed to 43 c! ents a s hare in the fiscal first quarter, which ended Oct. 29. Analysts on average had predicted 39 cents, according to Bloomberg data. Cisco also topped projections with its second-quarter forecast.
First-quarter net income fell to $1.78 billion, or 33 cents a share, from $1.93 billion, or 34 cents, a year earlier. Sales rose 4.7 percent to $11.3 billion in the period, compared with an estimate of $11 billion. Cisco’s gross margin narrowed to 62.4 percent last quarter, excluding some costs that beat the average estimate of 61.3 percent. The slight drop is margin is where I suspect Chambers’ quote stems from. It is clear that IBM (IBM), Lucent (ALU) as well as Brocade Communications (BRCD) have upped the ante on its core business.
Projections
Sales will grow 7 percent to 8 percent in the current quarter, the company said on a conference call. That equates to $11.14 billion to $11.24 billion, beating the $11.13 billion predicted by analysts. Earnings will be 42 cents to 44 cents a share, excluding some costs. The average estimate was 42 cents.
To fully appreciate what these numbers represent, investors have to also glance into how Cisco rose to power and just as swiftly fell from grace.
How the decline started
A “technology powerhouse” did not sufficiently describe Cisco in the early to mid 90s. For a brief period of time, the company shot up to the top as the largest tech company in the world by using a tried and true business strategy. It strategically acquired many of its competitors until it owned enough market share to preserve pricing power. The company figured out a way to combine great products and great relationships with its channel partners.
This gave Cisco a distinct advantage over anyone else who sought to enter its space, and then was further helped when the tech bubble ended any growth optimism that existed by the competition that was left standing. Cisco was so effective that it controlled well over 50% of the ! router m arket and over 70% of the switch market at its peak, while generating close to $10 billion annually in cash. That placed John Chambers in the pantheon of leaders who are considered superstar CEOs - it was brilliant!
But as with everything in life, Cisco soon learned that nothing lasts forever. When companies began rebuilding data centers and communications networks, Cisco’s competition was provided the opportunity they were waiting for. Through a series of missteps, Cisco became distracted by unnecessary bureaucracy such as when John Chambers replaced Cisco’s top-down decision making with committees of executives from across the company, where it created teams to provide strategic advice and evaluate project progress. In total, Cisco at one point had 59 internal standing committees.
Another strategic error by Chambers involved its entry into unattractive consumer businesses. New business lines included camcorders, TVs as well as the UCS, which is the integration of the many different parts of a communications network system. These moves allowed competitors Such as Hewlett-Packard, Juniper and F5 (FFIV) to catch Cisco unaware when they slashed prices on lower cost products.
Overnight, the extraordinary Cisco, for years a global tech-sector bellwether, became just another big company. It was clear to many except Cisco what its main problem was - it had too many branches and very little focus.
Restoring the brand
Cisco decided it was time to conduct some restructuring and abandon the committee of executives' way of operating and revert back to a more conventional top-down structure, while also reducing its workforce by 9%. At the time, I asked, will these measures work and are they too drastic? I called these changes “cutting the fat” but upon learning that 6,500 people would be out of a job, I had to adjust my thinking a little bit.
Though I questioned the merits of laying off 6,500 of its employees, as tough of a decision that was to! make, i t is one that has so far proven to be correct. Having now seen the results of some of these decisions I’m starting to think maybe it is possible for Cisco to once again become a growth company. This has strengthened my previous assessment that Cisco is a great value at current levels as opposed to its once perceived “value trap."
Summary
As I said previously, Cisco’s stock is clearly marching towards the mid $20s but it is going to require patience from investors who see the value that the company is beginning to generate. Clearly Cisco is demonstrating that it can still grow revenue by more than double digits and it is not farfetched to expect earnings to do the same. Value investors should really take a long look at one of the most dominant tech companies on the market at the moment, that is once again showing that maturity is no longer the enemy of growth.
Disclosure: I am long CSCO.
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