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By sonofed
September 27, 2001

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Here is my opinion, for what it's worth:

1. Doesn't Cisco still have the best router in the business?

Yes and no. Cisco clearly has a compelling story to tell the market or they wouldn't have the market share they enjoy. However, that story has little to do with claiming the best point product in a given category. Cisco wins because they can offer a customer a single, unified communications infrastructure that can support networking requirements from the desktop out to the core of a carrier network. That doesn't mean their products are bad, but very often it means that their products are not the best in any single point market. That's about what you'd expect, however, since attempting to maintain a clear technical superiority in every potential product category would be unbelievably expensive and would net only marginal gains in revenue.

2. Haven't they had solid management practices in the past?

Yes, but management got complacent and the company got hurt as a result. Their prior performance in a booming economy may not be a great indicator of their future potential results now that things are a lot tougher in the business sector.

Basically, They were acquiring companies much too quickly to effectively integrate the new companies into the overall Cisco structure, much less train their sales force in how to sell the new products. The net impacts were to dilute the culture of frugality and tight sales processes that had made Cisco successful in the first place; to create technology fiefdoms in management that hampered communication and resulted in redundant efforts and products; and to add a raft of duplicate and unnecessary employees to the payroll.

Also, despite vaunted financial and production controls, they ended up in a situation where they built up huge inventories in the face of an economic slowdown that they didn't see coming, despite warnings from several other segments of the economy. The net result was an earnings surprise Q2 last year and a huge write off of inventory in Q3. Hindsight is 20/20 and I don't believe management could have behaved differently given how they were accustomed to perceiving their market, but it's hard to pat them on the back unless you can simply forget about the several billion dollars of shareholder money their mistake cost.

3. Isn't almost all recent news positive about the companies future?

No, I don't think it is. The recent news I'm reading has management predicting 10% annual growth for this year based on a strong, broad based economic recovery in the second half of this fiscal year. For Q1 and Q2 they are predicting flat to -5% revenue growth. For a company trading at their P/E multiples, that doesn't sound like good news to me. Also, if the economic recovery doesn't appear on schedule (and it seems highly unlikely), even the 10% growth figure for this year will be a fond memory.

Sure, they have more or less stopped Juniper's incursion into their flagship market and they have the financial resources to weather the downturn better than most of their rivals, but that is not enough to offset the impact of general economic weakness and tremendous weakness in the carrier market in particular on the company's revenues.

4. Wouldn't it be wise for them to buy back as much stock now while its way down saving them billions perhaps?

Share buybacks are a bad idea in almost every case. In this case, Cisco is buying back a relatively small amount of its own stock compared to the total float and is using $3B+ of valuable cash to do it. In tough economic times, cash is king and spending cash on a stock buyback is foolish, especially when the overall impact, symbolism aside, is likely to be trivial.

Also, they are not saving themselves money by buying on the cheap. They are under no obligation to ever purchase Cisco stock at all, so purchasing now is just an additional expense to company will bear, not a smart investment strategy that the company will capitalize on in the future when the share price rises.

I would rather see them use the $3B to enter a new market or shore up existing markets to guarantee a solid future revenue stream rather than waste in on reducing the float from roughly 7.4B share to roughly 7.1B.

5. If they bought back wouldn't the price naturally rise?

No, I don't think it really would. Cisco does not have the financial resources to purchase enough stock to make a real difference in the overall stock price, especially in a market as uncertain as this one. If you assume the overall market cap stays the same, buying back roughly 260m shares would cause the average price for the remaining shares to rise roughly $0.50 each. That really isn't very impressive and that doesn't account for the potential negative impact of a slight drop in liquidity for the stock or the net impact Cisco no longer having the $3B cash. Also, given the economic uncertainty, a $0.50 rise could easily be given back and then shareholders will have nothing to show for the expenditure of $3B.

6. One other option. Is it rational to assume Cisco could be bought out?

No, I don't think Cisco would be a likely takeover target. Even at today's prices, the company is worth around $90B and I don't see a lot of companies with the clout or the money to pull off that sort of merger or acquisition.

The bottom line is that Cisco is a solid company, but the current stock valuation is still high relative to the underlying performance of the company given the soft economy.



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