Training and running advanced artificial intelligence (AI) models requires more than just powerful graphics processing units (GPUs). Those GPUs do the heavy lifting, but feeding the ultra-powerful chips with data can become a bottleneck. A cluster of servers with tens of thousands of GPUs linked together requires some heavy-duty networking gear to make it all work.
Cisco Systems (CSCO -0.50%) is the longtime leader in the switching and routing markets, with its proprietary products maintaining dominant market shares. Across the entire enterprise network infrastructure market, the company managed a 41% share in 2022, quadrupling that of its nearest competitor.
Cisco's model of bundling its proprietary hardware and software isn't appealing to everyone. A more flexible approach makes sense for the major cloud providers, which build data centers at incredible scale and have very specific networking needs.
Cisco competitor Arista Networks, which builds its networking gear using merchant silicon from third parties and layers a fully programmable operating system on top, has had great success in winning business from some of the cloud giants.
Going after the AI market
Given that the major cloud providers are scooping up the bulk of powerful GPUs to build out their AI capacity, Cisco would be missing out on a huge market without a change in strategy. The company hasn't had much of a presence among the major cloud providers in recent years, but its Silicon One family of networking chips is changing the picture.
"We regained our footing there because we listened and we showed flexibility with our willingness to disaggregate if they wanted to do so," said Cisco CEO Chuck Robbins during the latest earnings call, speaking of the major cloud providers. "So I think that the disaggregation and the flexibility and us listening to them and understanding what they wanted was the reason that we got back in," Robbins continued.
Cisco's Silicon One chips can power ultra-fast switches and routers, allowing cloud providers to build the networking architecture they need in their massive data centers. The chips are fully programmable and support massive data throughput, making them ideal for AI networks.
Cisco is having some early success with its AI-focused products and expects significant revenue down the road. The company's Ethernet AI fabric is deployed at three major hyperscale companies, and it expects to receive more than $1 billion in orders for AI infrastructure from major cloud providers in fiscal 2025. So far, the company has booked about $500 million in orders. By 2027, the market for AI switching is expected to top $10 billion.
Cisco will be going up against Arista, which is growing rapidly, thanks in part to a heavy dependence on Microsoft and Meta Platforms. Cisco's market share doesn't yield any advantages in winning business from major cloud providers, so its products must stand on their own. So far, the company appears to be gaining meaningful traction.
Is Cisco stock a buy?
Cisco generates more than $50 billion in revenue annually, so AI-related revenue will be a minor contribution for the foreseeable future. Even if demand for Cisco's AI products grows rapidly, the company's overall results are still heavily tied to the state of the economy. During times of economic uncertainty, Cisco's customers can pull back on tech spending and delay orders.
Cisco stock looks reasonably priced, trading for about 12 times the company's guidance for fiscal 2024 adjusted earnings. However, the company is facing some headwinds as customers work through products delivered as Cisco was bringing its backlog down to normal levels. Cisco expects one or two quarters of lower revenue before growth rebounds to more normal levels.
There's a risk that this slowdown will become more drawn out as customers pull back in an uncertain economic environment, which would put pressure on Cisco's profits. Still, a reasonable valuation coupled with a long-term opportunity to tap into the AI infrastructure market makes Cisco stock an interesting proposition.
