Air Pockets Are Still Impeding Cisco's Progress

At least Cisco (Nasdaq: CSCO  ) investors were given fair warning this time around. Shares of F5 Networks (Nasdaq: FFIV  ) got pummeled just a couple weeks ago, after missing analyst estimates slightly, but actually posted a decent quarter. Cisco had less to prove than F5, since expectations were low after its absolutely atrocious fiscal first-quarter report in November; however, the former tech leader actually may have outdone itself. Once again, Cisco does deserve this whipping.

Cisco missed analyst estimates and guided down year-over-year growth for the current fiscal third quarter from 8% to 6%. Disappointing as well were the company's margins, which also came in light at 62.4%, while analysts were looking for 63.5%. More concerning, though, was CEO John Chambers' response to an analyst that questioned his assertion that 62%-63% marked a floor for the company's margins. When asked how he could be so sure, Chambers responded, "you're throwing a fastball and a curveball." Those are definitely tough pitches to hit, but the competition is throwing knuckle-curves, and Cisco may have to live with lower prices and forget about swinging for the fences.

I was also pretty concerned, as many were, during last quarter's conference call when Chambers told analysts that the company was facing some temporary "air pockets," but his words in this quarter's earnings release didn't help soothe this uneasiness. Chambers said, "As a company, we are going through a period of transition," which is fine for a company that has a clear direction and strategy. However, Cisco still can't seem to figure out what exactly it wants to be, or how it is going to get there. 

Speaking about this transition on the conference call, Chambers said it is committed to its review and realignment of expenses, which is not exactly the best way to rally the troops, many who now must fear cuts. Unfortunately for investors, this transition could be a long process, especially as these air pockets continue to impede the company's progress.

New quarter, same problems
Air pockets still exist in Cisco's switch business, which is its largest, accounting for about 33% of Cisco's revenue. Sales were down by 7% for the quarter. Here Juniper Networks (NYSE: JNPR  ) appears to have cut into Cisco's market share with the help of its partnerships with IBM (NYSE: IBM  ) and other vendors.

Other air pockets reported last quarter have been persistent as well. An overreliance on government business was fine when countries were running up debt over before the financial crisis. However, as spending began to dry in the U.S. and Europe, especially as austerity kicked in, Cisco found that a huge chunk of its business had disappeared. While domestically the lack of spending was mainly on a local and state level, Chambers expressed that it was spreading to the federal level, and it would only get worse over the next several quarters.

Cisco also continued to see a drop off in set-top boxes and orders from cable operators. This quarter's 29% decline, though, is due not to a lack of demand, but instead to a loss of market share to competitors in this space like Motorola Mobility (NYSE: MMI  ) .

Cisco's consumer business continues to be a thorn its side as well, as consumer sales were down 15% during the quarter. Cisco has been attempting to grow this business both organically and through acquisition, but it has been unsuccessful with both. Its bizarre 2009 acquisition of Flip camera maker Pure Digital has been a flop, as has its attempt to enter the consumer teleconferencing market via the Umi on the back of its strong enterprise presence. If it's any conciliation, the consumer business only accounts for about 2% of the company's revenues, but who knows where they go from here -- expansion through more strategic acquisitions, or possibly divesting this business entirely.

Some good news?
The only good news I see for Cisco investors is the company's massive cash pile of more than $40 billion, even though only about $3 billion is in the United States. Cisco would have even more cash if it hadn't authorized more than $72 billion in share buybacks in its middling stock since 2001. Investors may have been better off if this cash was burning in a furnace somewhere.

Since the company is having a difficult time growing organically, perhaps it can put some of this cash to work to acquire some. Cisco has made three small acquisitions over the last three months, with the most recent related to its latest vision du jour, known as Videoscape, which allows content and service providers to distribute video across smartphone, mobile, and desktop devices. A larger splash may be necessary, though,  to set the path for real growth.

There will certainly be many analysts and pundits screaming how cheap shares are of this large-cap tech name, that was once a bellwether for the entire sector if not the economy. Value in this case is in the eye of the beholder and it is difficult to place any on a company that still can't find its way in a sector that has been blazing within a raging bull market. I'd suggest investors looking for value in large-cap tech to consider Hewlett-Packard (NYSE: HPQ  ) , a company that has forged a plan of attack and is forging ahead, regardless of what skeptics might say. Cisco is still moving in too many directions, but going nowhere fast.

Andrew Bond owns no shares in the companies listed. Juniper Networks is a Motley Fool Big Short short-sale pick. Motley Fool Alpha has opened a short position on Juniper Networks. The Fool has created a bull call spread position on Cisco Systems. Motley Fool Alpha owns shares of Cisco Systems. The Fool owns shares of International Business Machines. You can follow Andrew on Twitter @Bond0 or on his RSS feed. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


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  • Report this Comment On February 10, 2011, at 8:13 PM, BradReeseCom wrote:

    Hi Andrew,

    For the 1-year time period that ended on January 14, 2011, Cisco became the worst performing stock on the Dow Jones Industrial Average (DJIA).

    Cisco's reorganization of its product sales reporting continues to detail the sequential quarterly sales declines of its products (Cisco had a sequential total sales decline of -$343 million, the 2nd sequential total sales decline in a row for a total decline of -$429 million).

    Interestingly to me, during Q2'FY11 Cisco's much ballyhooed collaboration sales (which include the sales of Cisco's telepresence, Tandberg and unified communications products) sequentially declined by -$39 million.

    Also, Cisco's Q2'FY11 other sales (which includes the sales of Cisco's optical and emerging technologies products) sequentially declined by -$20 million.

    Cisco's Q2'FY11 router sales sequentially declined by -$132 million (keep in mind that the highly touted Cisco CRS-3 router appears to have recently caused network outages at both Comcast and AT&T). Tellingly, Cisco's Q2'FY11 router sales are down a whopping -$297 million from Cisco's Q2'FY08 router sales.

    Cisco's Q2'FY11 security sales sequentially declined by -$36 million (the 2nd sequential security sales decline in a row for a total decline of -$167 million, which works-out to be a stunning -32% decline from Q4'FY10).

    Finally, Cisco's Q2'FY11 switch sales sequentially declined by a staggering -$400 million (the 3rd sequential switch sales decline in a row for a total decline of -$510 million. It's also noteworthy that Cisco's Q2'FY11 switch sales are down -$198 million from Cisco's Q2'FY08 switch sales).

    Sincerely,

    Brad Reese

  • Report this Comment On February 10, 2011, at 8:14 PM, stan8331 wrote:

    I always knew that Cisco was potentially vulnerable to lower cost competitors in the switching arena, but I failed to realize that scenario had actually come to pass. At this point, I'm thankful my support for the company doesn't extend beyond an ill-timed CAPS selection.

  • Report this Comment On February 10, 2011, at 10:45 PM, MegaEurope wrote:

    Andrew wrote:

    "If it's any conciliation, the consumer business only accounts for about 2% of the company's revenues..."

    You mean "consolation".

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