Is Cisco’s Share Loss a Major Concern?

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Cisco (NASDAQ: CSCO  ) is a massive company that's struggling to find growth, as many smaller competitors have quietly moved in on major segments to steal market share. One of those important segments involves routers, both core and edge routers, with two companies in particular being Alcatel-Lucent (NYSE: ALU  ) and Juniper (NYSE: JNPR  ) .

Fundamental declines and missed opportunities
In Cisco's most recent quarter, total sales fell 7.4% year-over-year to $11.2 billion. While Cisco's total business revolves around communications and networking, one of its core segments is routing, which includes the delivery of content and various types of service.

In particular, Cisco has really dropped the ball when it comes to its routing business, which made up 21% of product revenue in the last quarter, as sales fell 11% year-over-year. Yet, for the most part, this is a segment within the market that is recovering from a cyclical slowdown, a segment where Cisco should achieve growth, but has been unable.

Large, diversified, and capitalizing on routers
Alcatel-Lucent is a large and direct competitor of Cisco, generating nearly $19 billion in revenue during the last 12 months. Also, in the last year, Alcatel's share price has soared 180% amid restructuring plans to dispose of unprofitable segments and focus instead on those that have been growing, such as the company's router business.

For Alcatel, routers are coupled in its core networking segment, a unit that accounted for more than 43% of total sales last quarter. Specifically, its routing division is one-third of the core networking segment, and in 2013 it grew 10.3% over 2012, marking the company's third year of double-digit growth.

Alcatel has managed to produce this growth by partnering with large telecom companies like AT&T, China Mobile, and Sprint to expand their 4G LTE networks into less populated areas and improve their networks in highly populated regions. Given the strong increase in data usage both in the U.S. and globally, this market could fuel double-digit growth for many years to come.

Smaller, but growing with ease
Juniper has soared 25% already this year, and the company is a Wall Street favorite in this space because nearly half of its total sales come from routers. During the fourth quarter, Juniper's router revenue grew 17% year-over-year, which far exceeds the company's 12.3% total growth in the quarter.

Juniper is much smaller than Alcatel-Lucent and Cisco, with annual sales less than $5 billion, but it has one of the most refreshed lines of routers in the industry, giving the company a natural advantage with top technology. As a result, Juniper supports a P/E ratio of 32, and is quite profitable with operating margins of nearly 13%.

While Juniper may appear a bit pricey, its growth and opportunity to expand globally are impressive. As a result, investors are willing to bet on long-term sustainability, as Juniper continues to demonstrate reasons for optimism.

No excuses, better opportunities
There are no reasons for Cisco to be trailing so far behind in the router industry with double-digit year-over-year declines. This is a growing industry where Cisco has an enormous presence, yet the fact that its peers are growing, and it is not, is often overlooked by investors simply because of the company's name recognition and history of consistency.

However, despite Cisco's underperforming stock and three consecutive quarters of disappointing fundamentals, Alcatel-Lucent -- a company that has soared in the last year -- likely presents a better investment opportunity. Not only is Alcatel growing and improving its core businesses, but at 0.5 times sales, with margins still improving, it's many times cheaper than Cisco at 2.5 times sales and margins that are under pressure.

Final thoughts
Essentially, Cisco is moving in the wrong direction in a very important segment. Instead of investing in Cisco for its total package, investors might be better served by selecting segments of the company's business that are strongest and finding competing companies that are performing better. In this case, those companies are Juniper and Alcatel-Lucent, from a both a growth and value perspective, as both represent a significantly better investment option.

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  • Report this Comment On February 25, 2014, at 11:36 AM, BradReeseCom wrote:

    Hi Brian,

    In my opinion, your above concerns are just the "tip of the iceberg" when it comes to "what is really driving down" Cisco's service provider revenue, for example The Wall Street Journal:

    "AT&T is planning to rebuild its sprawling network with less expensive, off-the-shelf equipment controlled by software, move could cut the company's capital costs by billions of dollars."

    The Union Bank of Switzerland analyst stated during Cisco's Q2'FY14 earnings conference call:

    "I am little surprised with these service provider segment for you continues to remain relatively weak. NCS has been off for some time, so I am surprised we are not seeing any traction there, so we would love to get your thoughts in terms of the portfolios there, room for further rationalization…"

    Here's Cisco CEO John Chambers' lame excuse of a reply:

    "In terms of service provider, we basically are again going with an architectural approach. We are literally saying how do you influence the key issues that are most important to the service provider from mobility to video, to cloud, to speed of services delivery, so reducing OpEx and CapEx and say how you approach these with an architectural approach. So I think this will be an industry where architectures will win and I think we are very well positioned versus our key traditional IT players and future challenges."

    Gee, Cisco's attacking the U.S. service provider market with an "architectural approach."

    Meanwhile according to AT&T:

    "AT&T's new plan means the company won't have to regularly rip out its routers and switches every time it wants to upgrade its network. Instead, it would simply update the software that governs how the gear works. The goal is to be able to quickly and remotely adjust network functions, including rerouting traffic, adding capacity and new features. 'What used to take 18 months should take minutes,' Mr. Donovan said.

    "The shift will mean the second-largest U.S. carrier will buy less specialized equipment from vendors such as Cisco... and instead purchase more generic hardware from a wider variety of producers."


    Brad Reese

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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