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Deep Dive: Is Cisco the King of Network Hardware?

By Matt Koppenheffer - Updated Apr 6, 2017 at 12:39PM

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Let's dig in for a close look at the network hardware industry.

Foolish investors who see investing as owning a piece of a company rather than a tradable piece of paper know that gathering a few easy-to-find numbers is rarely enough to build an investment case on. These fundamental investors need to know what makes a company's industry tick, where growth opportunities lie, and what the competitive environment looks like.

With that in mind, let's throw on our scuba gear and dive into the network hardware industry and see what we can find.

Why bother?
Networking equipment is the enabler of all of our data communication. Switches link up local machines, while routers link networks together and ensure that data gets to its intended target -- even if that target is around the world. Without networking gear, there's no Internet, it's as simple as that.

The expansion going on in the realm of data communication is staggering. Smartphones are allowing users to access vast amounts of data anytime, anywhere. Entertainment websites like Hulu and Netflix allow viewers to stream TV shows or entire movies with the click of a mouse. Voice and video chat over the Internet are everyday phenomena.

Meanwhile, on the business side, there are huge, growing opportunities as IT managers throw around words like "unified," "virtual," and "cloud." As networks have become larger, they have become more complex and cumbersome, and one of the next major steps forward in IT is bringing network infrastructure into easy-to-manage, seamless systems that combine software and hardware to increase efficiency, improve quality of service, and lower costs.

Who's got their hands in this pie?
Investors have access to quite a few players in the networking equipment industry. Here are five of the most prominent.

Company

Market Cap

Gross Margin

Operating Margin

Forward Price-to-Earnings Ratio

Cisco (Nasdaq: CSCO)

$136 billion

64.4%

22.2%

13.6

Hewlett-Packard (NYSE: HPQ)

$111 billion

23.4%

10.1%

10.0

Juniper (Nasdaq: JNPR)

$14 billion

65.5%

17.2%

21.4

Alcatel-Lucent (NYSE: ALU)

$6.3 billion

34.0%

(0.9%)

52.0

Brocade (Nasdaq: BRCD)

$2.3 billion

53.1%

10.7%

9.5

Source: Capital IQ (a Standard & Poor's company) and Yahoo! Finance.

When we look over the competitive landscape, Cisco is the clear leader in this industry. Not only is the company the largest, but it also delivers the most impressive margins. The reason is that Cisco has created good products, a strong brand, and a pretty rabid following, and therefore is typically able to charge more than its competitors and still keep its customers coming back.

That, however, doesn't mean there isn't room for Cisco to slip up or for competitors to gain ground. As Cisco has sought new avenues for growth, it has gone in a bunch of new directions. It's developed a big footprint in the telepresence market, gone head-to-head with Netgear in the consumer networking market, and could even end up on a collision course with Apple with the release of its Cius business tablet. Though none of these areas is too far divorced from Cisco's core business, hungry competitors like Juniper and Brocade will be ready to grab as much market share as they can if Cisco takes its eye off the ball.

At the same time, the entire industry has been very focused on the opportunity available in datacenters and virtualization. But the approach has been very different from company to company. Smaller players like Juniper and Brocade have partnered with other companies like VMware (NYSE: VMW), Oracle, IBM, Symantec, and EMC (NYSE: EMC) to build patchwork, but coherent, systems. Cisco, on the other hand, has used its size and the breadth of its product base to put together a virtually all-Cisco system while maintaining strategic alliances with EMC and VMware for storage and virtualization needs.

This promises to be a significant battleground as smaller players evangelize the advantages of having an open system that can accommodate products from a number of different venders, while Cisco pitches the ease and consistency of working with a single brand and provider.

A bit of a wild card in all of this is Hewlett-Packard. Late last year, HP decided to acquire network equipment manufacturer 3Com, which plopped the computing and printing giant right smack in the middle of the networking melee. Though 3Com could be considered one of the original gangsters (that's a technical term) of the networking industry, it had become somewhat of an also-ran as it failed to keep pace with Cisco.

3Com's future could get more interesting, though, since HP brings financial firepower to the table that can better match Cisco's impressive resources. However, the extent to which the acquisition and new owner are able to reenergize 3Com's presence remains to be seen.

Alcatel-Lucent, on the other hand, represents very little threat to Cisco or any of the other companies in the sector. It's an amalgamation of two companies that were at one time pretty solid before being run into the ground by their respective management teams. Today, it's a wounded, limping company that I have no problem marginalizing.

Avaya, which was spun off from Lucent, could actually be a more interesting competitor in the mix, particularly after acquiring Nortel's assets on the cheap. Unfortunately, Avaya was taken off the public markets by private equity firms in 2007.

Which should you buy?
Right now the easy answer to the question of which to buy is Cisco. For investors there's just too much in favor of the company and stock not to make it the prime consideration in the network equipment space.

Not only is Cisco the hands-down market leader, but it delivers the best margins, has a great balance sheet, and the stock is currently priced very reasonably. Even better, the company is much more than a collection of products, it's a strong brand that has a very dedicated following that will often choose products simply because they're Cisco -- even if competitors can offer superior performance. And if you think that sounds like Apple, then we're on the same page.

However, Cisco is also huge and it's unlikely that investors will see out-of-the-park gains on the giant's stock. For investors looking for more growth opportunity, Juniper and Brocade could be considerations.

Brocade is clearly the cheaper of the two right now, but it's cheaper for a reason. Its performance has been so-so, growth expectations are low, and it carries a significant amount of debt. But the low valuation could provide a cushion against those concerns. Plus, the company has at times been the subject of takeover rumors, which probably aren't farfetched given the company's size.

Juniper, on the other hand, has been a better performer and is a tougher competitor for Cisco. The current price tag, though, seems a bit high and probably takes into account much of the company's expected growth -- and then some. At a lower price, Juniper would be a much more attractive bet.

Do you have your own take on who will be the big winners in the network equipment industry? Head down to the comments section and share your thoughts.

This is why you just don't sell great stocks like Cisco.

VMware is a Motley Fool Rule Breakers recommendation. Apple, Netflix, and Netgear are Motley Fool Stock Advisor picks. The Fool owns shares of Oracle. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.

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Stocks Mentioned

Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$49.71 (6.54%) $3.05
HP Inc. Stock Quote
HP Inc.
HPQ
$34.90 (1.72%) $0.59
Brocade Communications Systems, Inc. Stock Quote
Brocade Communications Systems, Inc.
BRCD
Dell EMC Stock Quote
Dell EMC
EMC
VMware, Inc. Stock Quote
VMware, Inc.
VMW
$122.04 (0.88%) $1.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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