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Cisco Falls and the Industry Cheers

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It used to be that Cisco Systems (Nasdaq: CSCO  ) had its entire fist on the pulse of the informational technology industry. If Cisco had a good day in the market, chances are that other networking and enterprise computing stocks were doing great as well. And when Cisco sneezed, Silicon Valley tended to have a cough at the very least.

Not anymore. Cisco's third-quarter earnings, reported Wednesday night, came in above Street estimates with $0.42 of non-GAAP earnings per share on $10.9 billion in revenue. But the fourth-quarter outlook was downright dismal, and the long-term view even worse. CEO John Chambers is getting his hands very dirty these days:

  • As announced last week, Cisco is streamlining its operations and cutting some dead weight that doesn't belong with the core networking business.
  • Job cuts and efficiency programs should shave $1 billion of annual costs off the income statement. The exact nature of the headcount reductions will be shared by the end of the summer, and includes an early-retirement option for Cisco veterans who don't mind stepping out.
  • The most telling concession is this: the long-held goal of 12% to 17% annual sales growth is being thrown out the window in coming quarters; Cisco sees no more than 2% higher sales coming up.

"Throughout our history, Cisco has adopted and evolved to meet both challenges and opportunities," said Chambers. "This time is no different."

Except, it really is different this time.

So what's changed?
Throughout Cisco's history, the company has been able to lean on a unique social network. IBM (NYSE: IBM  ) and Hewlett-Packard (NYSE: HPQ  ) used to resell Cisco networks with their data center solutions. Cisco was the trusted networking brand, and the place you'd go when you needed something big, something complicated, or something mission-critical. Those deep connections with resellers and customers alike gave Cisco a more complete and balanced industry view than anybody else. Trends emerge quickly when a hundred enterprise-class customers start asking for the same thing.

This time, there are alternatives. Cisco basically told HP and Big Blue to get lost when it launched a server line, thus becoming a direct competitor more than a partner. IBM cut the cord and started reselling more Juniper Networks (Nasdaq: JNPR  ) and Brocade Communications (Nasdaq: BRCD  ) gear instead. HP got even angrier and decided to buy 3Com just to return the favor. Nobody confronts Cisco quite as viciously as HP does.

Now HP and Juniper are stealing business from Cisco, and nobody expects the stumbling giant to fight back anymore. So when Cisco's guidance disappoints, that's no longer a warning signal for the whole industry. Shares of Cisco rivals, from Juniper to Alcatel-Lucent (NYSE: ALU  ) , traded up as Cisco sank after that gloomy report. And why not? If Cisco suffers, the other guys are likely stealing its pie.

What's next?
I used to think of Chambers as a demigod of the IT business, in better position to divine and exploit market trends before they happen than anybody else, except perhaps tendril-intensive giants IBM or Microsoft (NYSE: MSFT  ) . But he has thrown it all away on a server move that never made any sense. The server systems are selling at a $900 million run rate today. That's nice, but hardly worth the trouble they caused. The damage you see today was dealt in 2009.

Cisco is too big to die here, but its glory days are over. Management has given up on its big growth dreams, which used to be actual plans. So enjoy the dividends, dear Cisco investor. Cisco shares are cheap at less than 13 times trailing earnings, but deservedly so and I don't see any catalysts that will turn the tide anytime soon. It's a trust issue with no quick fix.

What do I do now?
A lot of investors do believe in Cisco. It's a four-star CAPS stock (out of 5) with a 95% approval rating and a bullish real-money position for two Foolish newsletters. If I'm wrong and they're right, then Cisco is on its way to becoming a true end-to-end solutions provider for the data center, which doesn't sound bad in theory. You can bet on that at these low share prices if you want, but I'm not going there. Even John Chambers thinks that transformation will take years, or else he'd stick to that old mid-teens growth projection.

The proof is in the pudding, and Cisco makes plenty of news. The best way to stay on top of its progress -- or lack thereof -- is to add Cisco to your Foolish watchlist. That way, you'll be in the know as soon as Cisco's situation changes. Click here to get started.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Juniper Networks is a Motley Fool Big Short short-sale recommendation. Microsoft is a Motley Fool Inside Value pick. The Fool has created a bull call spread position on Cisco Systems. Alpha Newsletter Account, LLC has opened a short position on Juniper Networks. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of International Business Machines and Microsoft. Alpha Newsletter Account, LLC owns shares of Cisco Systems and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.

Read/Post Comments (6) | Recommend This Article (5)

Comments from our Foolish Readers

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 May 13, 2011, at 1:39 PM, Netteligent09 wrote:

    After years of failures, Cisco management from Consumer Products Group are ready for hire..catch them while you can.

  • Report this Comment On May 13, 2011, at 1:42 PM, BradReeseCom wrote:

    Hi Anders,

    Cisco's much ballyhooed data center sales sequentially declined during Q3FY11.

    Stunningly in my opinion, sales of the ultimate "phoenix" in Cisco's new product reporting category - data center sales, sequentially declined by -$41 million (a -9.6% drop) during Q3'FY11.

    Cisco's data center sales include the Application Networking, Nexus Switching, Storage and Unified Computing Systems (UCS) products.

    This is noteworthy (again in my opinion), because it's the first sequential quarterly data center sales decline since Cisco began reporting its new product category, which started with Q1'FY10.

    Until Q3'FY11, data center and services had been the only 2 sales categories at Cisco (since it reorganized its sales reporting), to never of had a sequential quarterly sales decline.

    Additionally, the first 2 Cisco Certified Architects (CCAr) have jumped to HP Networking.

    Back on June 15, 2010 Cisco published a three-part video interview of the networking industry's first two Cisco Certified Architects (CCAr), Alvaro Retana and Khalid Raza.

    The CCAr cert is considered the PhD of Cisco certifications and is the highest achievable cert offered by Cisco.

    Amazingly, I confirmed this week that Alvaro Retana and Khalid Raza both now work for HP Networking, contributing to HP's new FlexNetwork Architecture.

    So why do I find this so amazing?

    Well, according to Marc La Porte's CCIE Hall of Fame, there's only 3 Cisco Certified Architects (CCAr) in the entire world, and now the very first 2 work for HP.


    Brad Reese

  • Report this Comment On May 13, 2011, at 1:58 PM, kutani123 wrote:

    Chambers did have lot of time and should have done BIG re-structure 2 years ago.

    It's LATE but again this is Chambers last chance of his career to do, save Cisco and re-build credibility with his employee and most important his investors.

    4,000 to 5,000 of 73,400 FTE to layoff and early retirement ??

    It's definitely NOT ENOUGH!!!!!


    1. DUMP entire consumer business (SA, Linksys, Umi..) along with so many junks project nonstrategic areas where Cisco is not the No. 1 or No. 2 player such as network mgmt, eOS, health care, sport entertainment, Grid, internet business and many more

    2.Cut 1/2 of FAT 73,000 FTE as most of them(MUST GO FIRST BEFORE ENGS) useless, standalone, lazy management structure, incompetent execs, SVP, VPs, Dirs, mgrs, (they constantly hiring engs to build "empire", to F*** around instead of work) high level engineer such as fellow, principle, distinguish, who do NOTHING but carving papers (prepare prezo slides), meeting all day long, every day of the year, delay the decision and innovation

    3. Cut 2/3 of 40,000 contractors are currently happily "milking" Cisco to its last drop..

    4. Must CUT COST and SCALE DOWN India off-shore investment as it went out of control in every ways in the last couple years and the WORST and ineffective one in the industry. One wonders about the Indian productivity with tons of resource there and NOT much things to do. Smell VERY VERY VERY FISHY

  • Report this Comment On May 13, 2011, at 2:07 PM, kutani123 wrote:

    "Cisco management from Consumer Products Group are ready for hire.."

    Yep they are as ONLY ENGINEERS.

    NOT management level who are useless, incompetent as they DON'T have a CLUE about consumer business, strategy, marketing caused Cisco consumer BU miserable failure ...

    It'll be DISASTER for any company to hire them!! ..

  • Report this Comment On May 14, 2011, at 2:07 PM, BradReeseCom wrote:

    Cisco engineering is now led by Padmasree Warrior.

    Read what Warrior had to say about the introduction of the Apple iPhone:

    Don't hold your breath expecting Cisco under Warrior's leadership to create new technology that will appeal to the marketplace!


    Brad Reese

  • Report this Comment On March 21, 2012, at 11:53 AM, Evelyngermaine43 wrote:

    What the horse? I've never even heard of Cisco before now. Things are happening so fast these days. Global warming, human repopulation, DNS speed... I recently took an <a href="">ipv6 training</a>course just because I know that if I don't stay on top of the internet I'm going to get left in the dust. I know aboud HP and IBM. Should I know about Cisco still?

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