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Cisco Systems' 3 Biggest Growth Opportunities

By Timothy Green - Aug 30, 2016 at 7:17PM

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As the company transitions its business model, there are a few growth opportunities investors need to know about.

Image source: Cisco.

Networking hardware giant Cisco Systems (CSCO 1.55%) used to be considered a growth stock, with the company routinely producing double-digit annual revenue growth up until about 2010. Things have slowed down in recent years, and revenue even declined in fiscal 2014. Cisco is dominant in its core switching and routing markets, but those businesses aren't growing quickly or consistently.

That doesn't mean Cisco doesn't have some businesses that could propel revenue and earnings higher in the future. Here's a look at three of Cisco's biggest opportunities for growth.

Software

Cisco is still predominately a hardware company, selling the switches and routers that form the backbone of the Internet. But the company recognizes that its business model needs to change along with technology. Along with its fiscal fourth-quarter results, Cisco announced a restructuring plan that will see about 7% of its workforce eliminated. All of the cost savings will be reinvested in areas like security, collaboration, and cloud. Software ties it all together.

I argued about a year ago that software and services would be the key to Cisco's growth going forward, and it now appears that the company is taking a substantial step in that direction with this restructuring. At that time, Cisco expected software revenue to reach $9 billion in 2015, and then grow by 10% to 15% annually for the next 3-5 years. Software has the potential to represent more than one-quarter of Cisco's revenue by 2020.

During Cisco's fourth-quarter conference call, CEO Chuck Robbins summed up the company's progress in software:

Lastly, we continue to see great progress in our transition to software- and subscription-based models. I've mentioned the success we've had in this area in both security and collaboration, and overall, our product-deferred revenue related to our recurring software and subscription businesses grew 33% in Q4. Our momentum here is strong, and we'll continue to accelerate this transition.

Cisco is transforming into a supplier of integrated solutions involving hardware, software, and services. Hardware has carried Cisco this far, but software will be the key going forward.

Security

The fastest-growing segment for Cisco during the fourth quarter and the full fiscal year was security. The security business generated nearly $2 billion of revenue for Cisco during fiscal 2016, up 13% year over year, making Cisco one of the largest enterprise security companies in the world. Cisco has been acquiring smaller security companies over the past few years in an effort to build out its portfolio, and it will very likely continue to do so.

Cisco's security strategy is simple. Given that the enterprise security market is fragmented, with the typical large enterprise dealing with more than 50 security vendors, Cisco is building toward offering integrated solutions that can replace a large portion of those vendors. Unlike some cyber security companies that focus on one particular area, Cisco is looking to become a one-stop shop for enterprise security. If Cisco can make life simpler for its customers, it can win a considerable fraction of the market.

With breaches and hacks happening -- or at least being reported -- more frequently, the enterprise security market offers a long-term growth opportunity for Cisco. Security will likely remain a driving force behind Cisco's growth for years to come.

Collaboration

Cisco's third-largest segment is collaboration, which includes a broad range of products ranging from video conference equipment to cloud-based messaging applications. In fiscal 2016, the collaboration segment generated about $4.4 billion of revenue for Cisco, growing by 9%. That growth rate made it the second-fastest-growing segment for the company.

According to Synergy Research, Cisco led the overall collaboration market with a roughly 16% share during the fourth quarter of last year. The company has a strong lead in the on-premises portion of the market, claiming a 27% share, well ahead of second-place Microsoft. Cisco lags in the cloud-based portion of the market, though, with just a 5% share. Sales of on-premises systems slumped 3% year over year during the fourth quarter, while cloud-based solutions expanded by 10%. The total collaboration market grew by 4%.

Cloud-based solutions are only going to become more prevalent over time, and Cisco has positioned itself to capture that growth. Cisco Spark is the company's cloud-based messaging product, similar to applications from fast-growing start-ups like Slack. The company has made a handful of collaboration acquisitions over the past few years, including Acano, Pawaa, and Collaborate.com, and further acquisitions are likely as Cisco continues to go after the cloud-based portion of the market.

According to MarketsAndMarkets, the cloud collaboration market is expected to nearly double in size by 2021 to $42.5 billion. Cisco will be facing a lot of competition from both established companies and start-ups, but even modest gains in market share should be able to drive solid growth in the collaboration segment.

Timothy Green owns shares of Cisco Systems. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Cisco Systems. 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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