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It's difficult to be an investor in Cisco (NASDAQ: CSCO ) these days. After the company guided for a revenue decline of up to 10% for the current quarter, the stock slumped. Shares then slipped further as Cisco was downgraded by an analyst at Citi, with possible share loss to competitors Juniper Networks (NYSE: JNPR ) and Alcatel-Lucent (NYSE: ALU ) , along with an embrace of non-proprietary solutions, cited as the main reasons.
Cisco took yet another hit on Dec. 12 when the company lowered its growth outlook for the next 3-5 years. Previously targeting 5%-7% annual revenue growth, the company is now shooting for 3%-6% annual revenue growth, while expecting the current fiscal year, which ends in July, to show a 4% revenue decline. Shares of Cisco are now about 23% below the 52-week high, and the barrage of bad news seems like it will never end.
It's the perfect time to buy.
Competition is not new
Cisco has been able to achieve above-average margins over the past decade for a reason. This reason is not lack of competition, as competitors like Juniper and Alcatel have been trying to chip away at the Cisco juggernaut the whole time.
The fact that these companies have some new products on the market, temporarily winning some market share, is not a good reason to write off Cisco altogether. There are significant switching costs for customers of Cisco's core network switch and routing businesses, and there's no real reason to believe that Cisco is in danger of losing its competitive advantages.
One area of concern is the rise of software-defined networking, which threatens the proprietary hardware sold by Cisco. Alcatel recently launched new SDN technologies for its line of enterprise switches, allowing for increased programmability of enterprise networks. Juniper announced a similar initiative in October, makings its line of MX routers "SDN-ready," as the company put it. Cisco, after initially balking at SDN, recently launched its Insieme line of switches. Insieme allows for a high level of programmability while still requiring proprietary hardware from Cisco, offering a sort of hybrid SDN solution.
While these networking companies try to integrate SDN into their product portfolios without destroying their margins, big customers like Google are reportedly buying generic switches straight from manufacturers in China and Taiwan. These generic switches, coupled with open-source SDN technology, represent a real threat to the established players.
How big of a threat is an open question, but it seems like only very large companies like Google, which has massive networking needs, can feasibly bypass Cisco and the rest. Losing big customers is certainly not a good thing, but Cisco's dominance doesn't look to be going away anytime soon. Customers without the resources of Google don't have much choice.
At the end of trading on Dec. 12, shares of Cisco were priced at about $20.50. The company has a little more than $6 per share in net cash, leaving an enterprise value of about $14.50 per share. That's just 7.8 times fiscal 2013 earnings.
Of course, with revenue set to decline in the current fiscal year, profits will likely fall as well, so the forward ratio is probably a bit higher. There are two ways to think about Cisco. The first is to assume that the problems the company is facing are permanent, and that Cisco won't be able to compete with new technologies. The second is to assume that any issues that Cisco is having are temporary, and that the company will return to revenue and EPS growth in the next few years, albeit slow growth. If you believe the second statement, then the stock is outrageously inexpensive.
The bottom line
Unless you think that Cisco's core business is going to completely collapse, the stock is simply too cheap to ignore. I think that people overestimate the effects of disruptive technologies just as often as they underestimate them. In this case, the level of pessimism surrounding Cisco just doesn't match up with reality.
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