That's how you'd think a day like yesterday would play out, but it didn't. While all these networking stocks saw their prices fall, the drops were surprisingly muted. Juniper actually outperformed the broader Nasdaq, while Extreme Networks fell by less than 2% and Brocade rebounded to only a 3% loss.
I’m not sure the outsized sell-off Cisco saw relative to its rivals was justified. Much ado was made about Cisco's loss of market share to its rivals. However, most independent industry research says the company is holding firm or gaining market share in core markets. Juniper grew slightly faster than Cisco last quarter -- 22% versus Cisco's 19% year-over-year gains -- but after considering Juniper's much smaller size, it's hard to read into any meaningful market-share gains.
Granted, Cisco guided much lower than its rivals. Juniper says sales will rise by 11% next quarter, while Cisco guided down 5%. That's a tremendous disconnect. Surely some of this weakness is a Cisco problem that could benefit its rivals and isn't attributable to economic conditions, but there's one notable souring area of the economy that should roll past Cisco and collapse a wide swath of companies across a variety of industries.
Toss networking aside. It's obvious to think about Cisco and its rivals when contemplating who benefits or loses from Cisco's weak guidance, but the real losers will come from far-flung industries, and they’ll be any company with exposure to one key area: reliance on state governments for revenue.
Cisco's orders from the public sector were down, way down. Federal orders held firm, up in the mid-teens, but orders from cash-strapped state governments fell by 25% year over year. Not only that, but the change was also extremely rapid; between Cisco's fourth quarter and its just-released first-quarter results, state government orders collapsed by 48%!
Here's why this is important. Cisco keeps a lean order book. Orders total less than half a quarter's revenue, and for the most part, orders are fulfilled extremely quickly. That means that Cisco is an important leading indicator on broader government spending, and the state spending picture is ugly. A second point is that Cisco's quarter stretches a month past its rivals, ending in October. Because of that difference, we get some advanced visibility from Cisco.
The opportunity for investors here is that analysts from these diverse industries might not appreciate the insight into the rapid decline in state spending that Cisco has provided. Cisco's a heavily technical company, and analysts toiling away in industries that rely on state spending probably aren't studying its earnings call for nuggets of wisdom.
So I think investors would do well to identify companies with exposure to state governments. Here are three companies to consider:
(NYSE: RST): The company released its earnings report Wednesday night along with Cisco, and surprise, surprise -- investors were disappointed. Like Cisco, weakening sales bookings were a concern. Rosetta has shown growth in "institutional" sales (now 30% of company revenue), but you have to see the company's language software as an expense that state governments would forgo in dire economic times.
(NYSE: GD): Although the General is a defense stalwart, it's rapidly transforming itself from building tanks to building data centers. Its information-systems group accounts for more than one-third of company sales and serves not only the federal government but also state and local agencies. Long-term contracts should shelter General Dynamics for a while, so watch for a dwindling backlog in the company's "Information Systems and Technology" group as a sign of weakness.
(NYSE: MMS): The company provides health and HR program management and consulting services for local, state, and federal government. Of the three companies listed, MAXIMUS appears the most levered to state and local government spending.
You don't need to run out and bang down your broker's doors to sell these companies: The level of sales to state governments is often difficult to determine, and many of these companies have long-term contracts that should act as a buffer, but it's another area that investors need to watch closely in coming quarters.
Know of any other companies that could get beaten down if Cisco's government-spending warning turns out to be the canary in the coalmine? Let us know in the comments section below!