Should Cisco Split Up?

All good things come to an end, so they say. Is this the end for Cisco (Nasdaq: CSCO  ) ?

Back in the '90s, Cisco Systems was known as the company that "built the Internet backbone" (even if we weren't quite sure what an "Internet backbone" was at the time). More recently, the company's ventured into consumer electronics in an effort to spur ever greater Internet traffic. First it bought Scientific-Atlanta, going head-to-head with Motorola in the market for television digital video recorders. In later years, it expanded its video ambitions with the purchase of "Flip" maker Pure Digital, the development of the Umi home video-conferencing system, and the Cius tablet computer. Why, along the way, Cisco even built itself a home stereo system(!).

The logic behind Cisco's move into CE: The more consumer products out there, the greater consumer demand for bandwidth -- and the more routers and switches Cisco can sell.

And the problem: Not everyone is buying this new strategy.

Last week, Reuters reported on a new analysis of Cisco from equity analyzer Morningstar, which opined that despite Cisco management's infatuation with CE, "what investors would like is to see them more focused on their core market, like routers, switches and data centers, and de-emphasize or even exit some of these consumer businesses."

Troubles abound
Competitors like Juniper (Nasdaq: JNPR  ) , Hewlett-Packard (NYSE: HPQ  ) , and F5 Networks (Nasdaq: FFIV  ) are eating away at Cisco's "core," you see. Meanwhile, the company's CE experiment seems to be losing traction. Orders for Cisco's CE offerings as a group are said to have dropped 15% in the most recent quarter. Meanwhile, profitability at the company overall has declined for four straight quarters.

Raise your hand if you think the one has nothing to do with the other. As for Morningstar, at least, they're pretty sure the lack of traction in CE is having an effect on overall profitability, and it's high time to put an end to that. Cisco needs to cut bait on bad bets, and spin off its losing businesses. In short, Cisco needs to break itself up.

Break-en up and fly right?
And maybe Morningstar is right. Lord knows, it's hard extracting synergies from high-priced acquisitions such as the ones Cisco has been involving itself in lately. If Cisco has fallen victim to the perils of "diworsification," it won't be the first company to do so.

After all, there's a big difference between hawking thousands-of-dollar routers to corporate IT execs, and trying to interest the Fickle American Consumer to shell out a couple of Benjamins on the next new thing. You can see this difference pretty clearly in Cisco's self-delusion on the Umi product. Somehow, the company managed to convince itself that even years after Skype made home-based video conferencing a "free" service, customers would queue up to pay $599 up front, plus an additional $25 a month, for the chance to play Chat Roullette in hi-def.

So here, in a nutshell, is Cisco's problem: The company built its reputation on selling high-price routers and switches that "last forever." Which is great. But who even wants a Palm Pilot that lasts forever, when you know that an iPad 2 is waiting for you just a few years down the road? It's entirely possible that Cisco just isn't cut out for this kind of work. (Indeed, the numbers kind of prove that it isn't.)

Give me the ball, Coach!
But that's OK. Even if Cisco can't push Internet bandwidth demand itself, there are plenty of companies out there that can. Companies that are pretty darn good at it, in fact. Apple (Nasdaq: AAPL  ) , Netflix (Nasdaq: NFLX  ) , and Amazon (Nasdaq: AMZN  ) are already hard at work trying to boost Internet traffic -- not as their primary objective, of course, but as a direct consequence of the digital products they stream over the E-ways.

Call me a crazy optimist, but I suspect that if Cisco exits the CE game through a series of spinoffs, as Morningstar suggests -- or even if it closes up the CE shop, and stops making Flips, DVRs, and Internet stereos entirely -- the Internet would keep on growing. When you consider this likelihood, Morningstar's advice actually makes a whole lot of sense. Why lose money trying to do something you're no good at, in hopes of getting a chance to make more money at something you do do well ... when someone else is volunteering to take the money-losing, hard work off your hands for you?

My advice? Diworsification is for fools, Cisco. And for all your good intentions, you're no fool.

Actually, the contrary is closer to the truth. Motley Fool Alpha owns shares of Cisco Systems, and the Fool has created a bull call spread position on Cisco Systems. Also, Juniper Networks is a Motley Fool Big Short short-sale choice. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. The Fool has written puts on Apple, Motley Fool Alpha has opened a short position on Juniper Networks, and the Fool owns shares of Apple.

As for Fool contributor Rich Smith, he does not own shares of, nor is he short, any company named above. Check out his latest stock recommendations on Motley Fool CAPS. The Motley Fool has a disclosure policy.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (5) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 09, 2011, at 3:42 PM, valkur1 wrote:

    Rich, your information on Cisco's UMI is a bit outdated. Please see the recent announcement here:

    http://newsroom.cisco.com/dlls/2011/prod_030711b.html

    Prices have dropped to $499 / $399 for a lower end 720p version, and the service fee is now a $9.95. Also, Cisco is announcing UMI connect, a Skype/Facetime like video client on the PC/MAC for free. The differentiator here vs. these platforms, of course, would be the high quality HD video feed and the consumer-to-business connectivity (UMI Connect can talk to Enterprise TelePresence) that the other cannot offer.

  • Report this Comment On March 09, 2011, at 3:52 PM, valkur1 wrote:

    In addition, I would like to comment that Cisco's go-to-market strategy with consumer products has typically been to launch with Service Providers. For example, with Umi, Cisco launched the service with Verizon FiOS.

    What's the big deal you say here? Well, the difference is that Cisco is not building out the backend infrastructure to support it, Verizon is. Whereas if Apple or Skype or Google builds out a video service, they are the ones footing the cost for it. Verizon is getting the payback for from the $10 service fee, not Cisco. Thus, it's a win-win situation for Cisco because Verizon is sharing the load the product development costs.

  • Report this Comment On March 09, 2011, at 6:08 PM, SkippyJohnJones wrote:

    @Valkur1 - you are right about the pricing, but I think you may be missing the author's point. Consumer adoption of video conferencing is a big win for Cisco, and they don't need Umi to make it happen. Skype is hugely successful and growing across platforms. It is a matter of time before Apple puts Facetime on AppleTV via a cheap accessory camera. Logitech has already tried this with Google TV; consumers didn't bite because of perceived high prices. But fortunately, electronic component prices are coming down just as residential bandwidth is ramping up. The consumer to business connectivity is nice, but not a huge scale game changer.

    Flip video is great, but most high end phones and iPods do a pretty similar job at the same price, with more functionality. Cisco will continue to sell plenty of Flips, but consumers don't need to be convinced to put pictures and videos on the internet. Facebook and YouTube have made it incredibly easy and popular, and the hardware is irrelevant. Again, Cisco is a winner with its core businesses, even without a major share in CE hardware.

  • Report this Comment On March 10, 2011, at 11:56 AM, BradReeseCom wrote:

    HI Rich,

    A whopping 45 million shares (i.e. 50.56% and/or $910 million in Cisco shareholder cash) of Cisco's total Q2'FY11 stock buybacks went to support Cisco's dilutive management compensation practices!

    Obviously, it doesn't matter anymore what results Cisco's management produces.

    Heck, Cisco's management will just continue to cash-in big time on Cisco's shareholder cash!

    Sincerely,

    Brad Reese

  • Report this Comment On March 10, 2011, at 2:15 PM, keyakiy2k wrote:

    If I were any smarter, I'd bet that @valkur1 is a Cisco employee based on the terminology he uses.

    But maybe I'm wrong.

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