Can Cisco Cut Its Way Out of This Mess?

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Everybody expects some drastic changes of Cisco Systems (Nasdaq: CSCO  ) . How far is the company willing to go?

After CEO John Chambers issued a public "mea culpa" back in April -- and a singable one at that -- its shares have fallen by a market-lagging 8.4%. Chambers promised bold changes and presented a pared-down strategy that would fit just as well with today's IBM (NYSE: IBM  ) or Hewlett-Packard (NYSE: HPQ  ) . Cisco wants to own the data center inside and out and doesn't mind dropping some consumer businesses to get there.

This week, Gleacher analyst Brian Marshall predicted as many as 5,000 headcount reductions that would reduce annual costs by about $1 billion and pad next year's earnings by 8%. To complete the strategy change, Cisco would then need to merge with storage giant EMC (NYSE: EMC  ) to gain much-needed storage and virtualization exposure -- and finally lower its long-term targets for both growth and margin.

Investors saw that research note and shrugged as Cisco shares fell alongside the general market on a gloomy Monday.

But Cisco's stock put some spring in its step on Tuesday, when Bloomberg reported an even larger slimming effort. Through a combination of straight-up layoffs and early retirement, Bloomberg's anonymous sources expect about 10,000 Cisco staffers to be lining up at their local soup kitchens. Shares jumped more than 2% on the news.

Let's assume that Bloomberg's sources are correct. Will a leaner, meaner Cisco be a renewed menace to competitors HP, Juniper Networks (NYSE: JNPR  ) , and Alcatel-Lucent (NYSE: ALU  ) , which have been lining up to steal Cisco's business lately?

I'm not so sure. This networking giant may have seen its peak already -- not in terms of revenue but most likely from a market-share perspective. The boneheaded decision to start selling Cisco-branded servers transformed the company from a default choice of IT managers and resellers everywhere into just another wannabe-IBM vertical integrator, easily replaced. That's where today's troubles started, and now Cisco has no choice but to stay the course.

In a few years, Cisco might be a lean, mean cash machine with a killer dividend and modest growth. There's a bumpy road leading up to that day -- and that's assuming that these changes all work out for the best. If you want to see a much better opportunity in the networking sector, I'd suggest reading a free report on that topic. With or without Cisco up front, the hunt for ever more bandwidth continues.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. The Motley Fool owns shares of EMC, Cisco, and IBM and has created a bull call spread position on Cisco. Motley Fool newsletter services have recommended buying shares of Cisco and shorting Juniper Networks. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 July 12, 2011, at 11:56 PM, DavidWMcCulloch wrote:

    Hi Anders - Your labeling of Cisco's move into the server market as 'boneheaded' is absurd.

    In just two years since entering the market with its Unified Computing System, Cisco has taken almost twenty points of share and become the number two player AHEAD of IBM in the x86 blade category - which is the fastest growing segment of the server market overall.

    In the same period, HP's share slipped by 10.9%. Cisco is actually now the #3 vendor worldwide in this category, and sales continue to grow rapidly.

    For a more up-to-date perspective on our success in this market, your readers might like to check out this Wall Street Journal story:

    Best regards,

    David McCulloch

    Director, Corporate Communications


  • Report this Comment On July 13, 2011, at 3:59 AM, vinhn wrote:

    Hmmmm... how about a server market share deep dive?

  • Report this Comment On July 13, 2011, at 5:45 AM, TMFZahrim wrote:

    David, I appreciate you filling in the picture with some hard data, and I'm not saying that the servers haven't been successful.

    But wouldn't you agree that this move damaged your sell-through relationships with IBM, HP, and others? It sure changed how I think about Cisco -- wouldn't at least a few IT directors have their heads turned too?

    In short, I think that the server success comes at the very dear price of failure elsewhere, and this outcome was obvious from Day One. Was it worth it?

    Foolish best,


  • Report this Comment On July 13, 2011, at 12:50 PM, andresmitchell wrote:

    To David McCulloch I would say ok, we'll give you a mild success with the entry into servers. Unfortunately, the rest of the company and its products are a mess. The Cius will be a disaster. Riverbed, FFIV, and JNPR are eating your lunch and John Chambers is, in my opinion, the worst CEO in the Fortune 500. The problems are monumental and mounting. It looks like a company in terminal decline. As a long time shareholder, I have never had more doubt about the company's future. You have much bigger issues to deal with. If you are a director of communications, you need to somehow get the message out that the company is not in full blow collapse and headed for utter failure. As a customer, I would not buy from a company that appears to be in disarray. As an investor, I would not buy stock in a company that appears directionless and totally broken. That's the message that needs to get out. I think Cisco is doomed and I haven't seen anything out of the company to indicate otherwise.

  • Report this Comment On July 13, 2011, at 12:53 PM, andresmitchell wrote:

    And yes Anders, you are correct. This was a strategic failure among many strategic failures over the past several years. The question with Cisco becomes "what have they done right?" I can't think of anything for probably a decade.

  • Report this Comment On July 18, 2011, at 1:28 AM, DavidWMcCulloch wrote:

    Hi Anders and Andresmitchell,

    Thanks for the interest in the Cisco and the observations on my reply. Let me offer a few more thoughts.

    First of all, yes, the dynamic with HP has changed considerably in the past two years; the company is now clearly an out-and-out competitor, but let's not forget that HP fired the first shot. The company was already aggressively ramping up its networking business when Cisco unveiled the Unified Computing System. You might say that the writing was on the wall.

    IBM, on the other hand, remains a good Cisco partner. We partner in many areas where it makes sense for our customers to do so, including, incidentally, in the data center.

    As for the suggestion that success in the server market came at the price of failure elsewhere, and the suggestion that Cisco is "in full blow collapse", I appreciate both perspectives, but a simple look at the facts should dispel those notions.

    Cisco generated $40B in revenues last year; that's the most ever in the company's history. Simultaneously, the company generated net income of $7.8 billion GAAP.

    Of the 21 major technology markets in which Cisco competes, the company is #1 or #2 player by market share in 16 of them. Perhaps more importantly, Cisco was GAINING share in 10 of those markets as of the end of calendar year 2010.

    In some of the markets where Cisco has lost share (most visibly in switching) our customer port share (a better reflection of customer retention) has been very consistent over the past two years. Cisco is losing revenue to market economics as we drive better price/performance in our products. We're not losing out to competitors.

    All of that said, do we have some work to do? Absolutely. Our CEO has made that very clear. We're in the midst of a transition designed to deliver a leaner, stronger Cisco, and to maximize shareholder return.

    But Cisco is by no means failing. The company is re-tooling and re-focusing, innovating and fighting harder than ever for the loyalty of its customers.

    Perhaps on that last note, it's worth reflecting on Cisco Live, our annual customer event, which took place in Las Vegas last week.

    16,000 customers and partners attended the event. That's the most in our 26 year history, and a 21% increase on 2010. The energy and passion from customers at the event was electric. The excitement for our products and technology was palpable. Does that sound like a failing company? Not to me, it doesn't.

    I look forward to proving you both wrong! ;-)

    Best regards,

    David McCulloch

    Director, Corporate Communications


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