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November 10, 2000

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Rat's Broadband Bandwagon

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Subject:  Re: BB do Old Kings, get killed?
Author:  BruceBrown

Tulsee wrote:

Mr. Brown, sir. Having read about AT&T's break-up. And Tinkers link to Cisco's "predicted" future demise. *Got me to wondering, what happen's to "aged"-Gorillas & Kings?? Do they crash and burn, (see Intel's recent drop) from having way-high P/E's. Easy-come, easy-go. *** But more importantly, how can an investor (in for instance JNPR or jdsu) realize, if his money is being well spent. Especially on acquisitions like SDLI ? Would these numbers show-up on balance sheets? For instance TMF's "management effectiveness". * In days of old, Kings were in power for life. So the only way someone else could come to power, was if the king died in battle. Or of old age their-by his first-born-son would be king, after his death. *So my question is, just how bloody will it get for CSCO if; WallStreet decides to crown JNPR, it's new king! Because without CSCo's over-inflated P/E, its just another behemoth that overpaid for all those many acquisitions.

Hi, mitroae. I assume that you've read and are familiar with all of the terminology within The Gorilla Game to know the difference of a royalty game and a gorilla game. Likewise, I would assume that you are familiar with the technology adoption life cycle and what the difference between tornado and Main Street within the TALC is. Knowing this and the citations quoted as examples in that book will address most of your questions above.

In terms of optical growth, Cisco is involved in a tornado growth in that segment. They reported 40% sequential and 500% y/y growth in this segment. Cisco's history, beginning with the initial router business in the 1989/1990, found them participating in other tornado growth throughout the decade that included intelligent hubs in 1989/1990, LAN switches in 1994/1994/1995/1996, remote access concentrators in 1994 and has continued with things like voice over IP and optical which we are seeing today. That's not to say that every market they participate in is a gorilla game because it is not. Much of it is within the confines of a royalty game. Yet, Cisco's 'network effect' of using their gorilla position in the router/IOS market allowed them to move in, execute and dominate various categories they participate in. It's one reason I personally hold Cisco shares and not shares of Lucent or Nortel.

We also see the ability of other gorillas that emerged from a tornado to broaden their playing space into other markets. Siebel, i2, PeopleSoft, Oracle, Microsoft are some examples in the software application vendors. The network applications market is rekindling some of these and Siebel as well as i2 (as examples) are doing quite well at using classic tornado growth in other segments than their core niche to continue the 'story'.

In days of old, Kings were in power for life. So the only way someone else could come to power, was if the king died in battle. Or of old age their-by his first-born-son would be king, after his death.

Well, lots not confuse that with the metaphors used in gorilla gaming/royalty gaming. A king, in gorilla gaming, is a king because it holds at least 2x the market share of the nearest competitor. Once that 2x market share is lost, then it becomes a game of princes against princes. EMC, JDS Uniphase, Broadcom, Network Appliance, Brocade are probably the best representatives of "kings" in their respective niches using the market share axiom. Each has their own unique 'moat' built around the castle and the barriers to getting over that moat and to the castle for destruction are unique. What happens to a King when that market share of at least 2x the nearest competitor is broached? The classic example in the PC commodity box maker market was Compaq's Kingship of 2x market share being taking away by the Prince with attitude of Dell Computer. That's a unique game in high technology that never had the niche market control or margins that are representative in enabling-technology (be it hardware or software) because the box makers (more than any other segment) assembled other people's technology which lends itself more to the commodity side of technology. They were manufacturers and marketers. Dell's direct model and supply chain changed the industry and it was this business model itself that was the real threat to Compaq's model. In other words, the business model was the real winner. Dell executed to perfection and has proven to be one of the best investments through that cycle of 1989 to 1999.

Aging gorillas move through the TALC and eventually end up as a service company much like IBM is today (yet, they maintain their domination of the mainframe market). Today's breed of gorilla like Cisco, Intel, Microsoft have been stronger or proved to have had more longevity than any in the past. Cisco happens to have the good fortune of having a foot in the enterprise networking TALC as well as the IP/Broadband TALC. A double whammy if you will. With the entrance into the Voice over IP and the optical space tornadoes, Cisco is enjoying the luxury of extended growth that nobody could have predicted 4, 5, 6, 7 years ago.

Look at the past 12 quarters from a y/y perspective:

growth
1,592,377 2,022,000 27%
1,647,871 2,192,000 33%
1,765,097 2,400,000 36%
1,874,000 2,598,000 39%
2,022,000 2,845,000 41%
2,192,000 3,171,000 45%
2,400,000 3,559,000 48%
2,598,000 3,918,000 51%
2,845,000 4,357,000 53%
3,171,000 4,933,000 56%
3,559,000 5,720,000 61%
3,918,000 6,519,000 66%

I would view that as accelerating growth.

Management's usually conservative guidance raised their previous growth guidance of 30 - 50% last night to 50 - 60% going forward. A majority of that will be coming from the optical tornado where they predict amazing revenue growth in the next few years. The link to the "Disaggregation of the Giant Cisco" article by Fayad Abbasi was yet another piece of information that I usually file in my 'noise' bin. Yet, it's no secret that in addition to Cisco, I have placed my investment bets on companies like Juniper and Redback (as well as others) for some of the thoughts presented in that article. What the market is willing to reward Cisco as a CAP (competitive advantage period) balloon remains yet to be seen. We've seen what the market has said this year in regards to that even though growth has continued forward. Perhaps it was so far extended that the CAP has been hanging out and been constrained by the high market multiples that investors and the market placed upon it going into this year. Management seems to be convinced that they can maintain that CAP by providing growth. If you look at that growth chart above and couple it with their raising growth estimates going forward, you have to believe they are indeed focused on growth. Big growth. Time will tell what the market says about the CAP award.

Because without CSCo's over-inflated P/E, its just another behemoth that overpaid for all those many acquisitions.

Well, in terms of the optical growth experienced to date at Cisco and the projections Cisco gave for the next couple of years growth in that category being in the billions, it would appear that use of the word "overpayment" is misinformation. Those investments were wise and are going to pay off in a handsome manner. Likewise, we could argue about the P/E being over-inflated based on the revenue growth rate. If their conservative growth guidance is surpassed, then we're looking at a possible undervaluation. However, we'll simply have to wait and see what happens. I can think of a heck of a lot of investments or companies that we could be sitting around arguing about in terms of being losers, yet this one simply doesn't have the required elements needed to be tossed in that heap.

BB
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