Is Cisco the New Microsoft?

Cisco has been unfairly criticized for its declining revenues, with investors likening it to Microsoft and its fall from grace. However, the company's business-model transitions and its foray into the Internet of Things will help Cisco turn around its fortunes.

Feb 19, 2014 at 11:45PM

Few tech stocks are as hated right now as Cisco (NASDAQ:CSCO). In fact, investors have such a low opinion of the stock that it's currently trading lower than where it was a decade ago, despite the company having seen considerable growth in both its top and bottom lines.

Cisco's precarious position is eerily reminiscent of software giant Microsoft (NASDAQ:MSFT), which investors also loved to hate. Microsoft was seen as an embodiment of the PC, and PCs were feared to be quickly going the way of the dinosaur after Apple (NASDAQ:AAPL) popularized iPads and iPhones, and Google (NASDAQ:GOOGL) brought the joy of the smartphone to the masses with its hugely popular Android OS. Cisco, the giant switch manufacturer, is nowadays seen as a huge, clumsy behemoth that cannot reinvent itself fast enough to keep pace with changing technology. But, that perception is just wrong.

Although there is a whole gamut of what one could point out as being "wrong" with Cisco, the perceived threat that surrounds software-defined networks, or SDN, caps it all. Cisco is the dominant force in networking hardware, and many of its customers are locked in for many years due to the company's proprietary products. Cisco integrates embedded software in its networking hardware. SDN, on the other hand, makes it possible for companies to purchase commodity hardware, then install third-party software. This effectively cuts out Cisco from the supply chain. Google is already trying to give Cisco a scare by ordering its switches directly from Asia.

A recent article by Barron's examined the threat of SDN to Cisco, and noted that the technology is still in its early stages. According to Barron's, there won't be any meaningful adoption of SDN with adequate potential to shuffle the decks for networking hardware companies such as Cisco until 2017.

Cisco has not just been sitting on its derriere and cursing its luck. The company recently unveiled a line of hybrid switches it has dubbed "Insieme," which allow customers to try out SDN while still maintaining the need for Cisco's proprietary products.

According to Barron's, as many as 20% of Cisco's customers might eventually consider trying out hybrid switches. Cisco says that Insieme switches ''are 27% less expensive'' over the long run than other commodity hardware, and cites strong sales of the new switches to buttress its point.

Pessimism surrounding the weakness Cisco is experiencing in emerging markets is also probably overdone since the majority of the company's income comes from the American market.


Source: Cisco products

Business model transitions
Cisco is currently in the throes of drastic business model transitions and product cycle transitions under the tutelage of CEO John Chambers. The networking equipment maker has been struggling to find a regular cadence of revenue as it continues to evolve its product portfolio.

Cisco has been withdrawing from the low-margin set-top box hardware business. It is also remodeling its service provider video business to a recurring revenue model that is built around NDS' cloud computing platform. The company acquired NDS in 2012.

Source: Cisco products

Cisco's shift from set-top boxes comes with huge benefits, since the industry is almost fully commoditized, which significantly elevates the risk of obsolescence. NDS' super-high gross margins trump Cisco's core business by a mile. Additionally, NDS has signed multi-year agreements with various players that provide excellent future revenue visibility.

Investors tend to overlook the fact that Cisco has recorded considerable success in the blade server market, despite being a relatively new entrant. Since its entry into this market barely five years ago, Cisco has gained so much traction that it's now the second largest player in the x86 blade server market, with a 19% slice of the global market and a 28% share of the U.S. market.

Cisco is also very keen on monetizing the still-nascent Internet of Things, or IoT, and unveiled its own IoT router last September. Chief executive John Chambers estimates that the IoT will grow into a $14 trillion industry by 2020.

Peers in comparison
Microsoft has managed to shake off its image as a company well past its prime, and is showing serious intent on unseating Apple and its iOS platform with its own Windows Phone platform to become the second most popular mobile OS after Google's Android OS.

Foolish bottom line
Cisco has been unfairly crucified by investors, perhaps because they hold the company to such high standards. The company's business remodeling and its foray into the Internet of Things may very well be the secret ingredient that might completely turn around its fortunes.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Apple, Cisco Systems, and Google. The Motley Fool owns shares of Apple, Google, 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. The Motley Fool has a disclosure policy.

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