Cisco's (NASDAQ: CSCO ) investors were hardly impressed by the firm's lackluster first-quarter results. Market overreaction to the earnings call resulted in the shares tanking a massive 11% on Nov.13, the day following the report. What spooked investors were the firm's expectations of lower revenue in the second-quarter by 8%-10%; analysts had expected a 4% growth. Cisco's management also expected earnings per share for the second quarter to come in lower at $0.45- $0.47 versus earlier consensus estimates of $0.52.
But, was it really all doom and gloom at Cisco? Not by long stretch. Despite the headwinds, the giant networking equipment maker is facing in emerging markets, it delivered EPS of $0.53, better than analysts' expectations of $0.51, and improved its gross margins from 60.95% a year ago to 61.29%.
Most of Cisco's core businesses remain fundamentally sound, and the lower revenue guidance is a reflection of the drastic restructuring the firm is currently undertaking.
Headwinds in emerging markets
Cisco's is facing major weaknesses in emerging markets. Investors are particularly worried that political tensions regarding national issues between the U.S. and China, the leading emerging market for many tech firms, is going to muddy the waters even further for Cisco.
The Heritage Foundation pointed out how a recent Congressional Intelligence Committee report concluded that both Huawei and ZTE should ''not be considered as reliable partners'' for American firms with work involving sensitive systems.
Cisco derives about 58% of its revenue from the U.S., while emerging markets contribute about 22% of its revenue. China accounts for just 10% of its overall revenue, which in my opinion is not big enough to warrant the kind of panic we are witnessing among Cisco investors. Cisco might actually end up selling more in the U.S. if businesses here end up taking the Congressional Intelligence Committee report seriously.
Business model transitions
Cisco has continued to undertake business model transitions as well as product cycle transitions under the watchful eye of CEO John Chambers. The company has, admittedly, been struggling to find regular cadence as it continues to evolve it product portfolio.
Cisco is walking away from its low-margins set-top box hardware business. The firm is also migrating its service provider video business to a recurring revenue model built around NDS' cloud computing platform. Cisco acquired NDS in 2012.
The shift from set-top boxes will be hugely beneficial to Cisco, since the industry has become fully commoditized and the risk of obsolescence is quite high. NDS gross margins trump Cisco's by a mile. Additionally, NDS has multi-year agreements that provide better revenue visibility.
Internet of Things
Cisco is in a good position to leverage its early lead in the nascent Internet of Things, or IoT, industry. The firm is one of a handful of companies that have proved to be really serious about monetizing the IoT concept. The firm recently unveiled an IoT router in September 2013. The IoT router is quite unlike the Cisco CRS core router, but rather, a network fabric designed to provide networks from centralized systems to several distributed architectures that can accommodate IoT-enabled ''things'' such as cars, homes, and various machines.
In a recent interview with the Online Barron, Cisco CEO, John Chambers, predicted the IoT will grow to a $14 trillion global industry by 2020. Other IoT growth estimates are from Intel, which projects that 3.8 billion devices will be connected to the Internet by 2015, and ABI Research, which predicts that 30 billion devices will be connected by 2020. Although it's still quite early to tell which figure is more accurate, indications are that Cisco might be on to something huge.
Cisco vs Microsoft: friend or foe?
Cisco competes directly with Microsoft (NASDAQ: MSFT ) in the field of Unified Communications, or UC. Cisco's UC is facing greater competition from Microsoft's Lync, with evidence of greater adoption of Lync in recent times. Businesses that prefer Lync do so because of its easy integration into Share Point, Office, and Exchange. Microsoft's better developer environment is another big reason.
Overall, Cisco continues to be the global UC leader due its ability to leverage its huge installed VoIP base. Cisco's UC has been hailed as more mature, has a better voice quality, and, in many cases, is cheaper than Lync. A joint survey carried out by Tech Target and ZK Research in late 2012 revealed that 43% of businesses still prefer Cisco as their primary UC vendor compared to Microsoft's 26.5%.
Despite rivalry in the UC space, Cisco recently announced that plans were under way for the company and Microsoft to collaborate in the development and deployment of private and hybrid cloud services.
Although Cisco is facing pressure from several quarters in the near-term, the tech firm remains a great long-term investment. The company's internal business model restructuring, and its move to consolidate its early lead in the IoT, is likely to yield huge benefits in the near future.
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