Cisco Systems (NASDAQ:CSCO) announced last week some key initiatives that represent a huge shift in the legacy network vendor's strategy. Investors should benefit from this major transformation over the long term.
Cisco has been struggling with cloud networking
Cisco has been profiting from the development of the internet and the increase in network traffic over the last couple of decades. And with the growth of online services such as video streaming and gaming, Cisco forecasts that global network traffic will grow by 26% annually through 2022.
But Cisco's core network business has evolved over the last few years. Traditional companies just want a trouble-free, resilient, and high-performing network that supports their businesses, and Cisco's proprietary and monolithic solutions deliver that. However, emerging cloud giants such as Amazon with Amazon Web Services and Microsoft with Azure need more. They demand flexible, scalable, cost-efficient, and high-speed solutions to support the explosive growth of their huge networks.
Since it was not able to address this new demand with its legacy portfolio, Cisco lost market share in the high-speed data center switching market, and other vendors such as Arista Networks (NYSE:ANET) took advantage of this weakness. With its tailor-made network solutions for cloud titans, Arista grew its revenue from $584.1 million in 2014 to $2.45 billion over the last 12 months.
In addition, some other threats emerged. For instance, the giant service provider AT&T (NYSE:T) announced it was developing its own white box networking solution, which, in contrast with Cisco's monolithic offering, consists of disaggregating software and hardware. This type of solution allows a network operating system to run on any compatible network hardware, which would prevent Cisco from upselling its integrated hardware and software.
Cisco's plan represents a huge shift in strategy
Traditional companies still demand a network that just works. But Cisco needed to address the new requirements from cloud titans. Thus, Cisco's plan -- which management says is the result of five years of effort and $1 billion of research and development -- represents a major shift for the company.
Cisco now proposes its own silicon architecture (the brain of a network device): Cisco Silicon One. The network vendor has been using its own silicons for a long time, which makes sense given its large scale. But other companies can now develop their own network devices -- which will compete with Cisco -- based on Cisco's chipset. Network vendors such as Arista and Juniper Networks are not likely to purchase chipsets from their largest competitor. But with this strategy, Cisco targets cloud titans and giant service providers that look to develop their own network devices.
Also, Cisco announced another major shift in its strategy: Its new network operating system, IOS XR7, can run on top of compatible competitors' network devices. Again, this strategy addresses the cloud and service providers market.
In addition, Cisco announced that its new network devices -- Cisco 8000 -- were based on Cisco Silicon One. And customers have the option to run these new devices with their own network operating systems or with Cisco's IOS XR7.
These announcements mean Cisco completely disaggregated its software from its hardware to adapt to the cloud networking data center market. In addition to its legacy business, the company became a vendor of silicon solutions, white boxes (network devices without operating systems), and stand-alone network operating systems.
Management also stressed the flexibility and performance of its new Cisco 8000 devices as well as its low power consumption. But the key element of this series of announcements remains Cisco's major strategic shift to remain relevant and address the evolving demand from cloud titans and service providers. The company did not stay stubborn in selling its legacy solutions, which would have eroded its dominant position in the networking market.
Thus, given its reasonable forward P/E ratio of 13.3, its attractive 3.07% dividend yield, and its large $8.4 billion cash position net of debt, Cisco remains an attractive tech stock for long-term and dividend investors.