This article is part of our Rising Stars portfolio series.

If you've been reading the financial sites recently, surely you know that Cisco (Nasdaq: CSCO) is in value territory. Its trailing P/E is 12, and its forward P/E stands at just 9. It also continually throws off massive amounts of cash. In the past 12 months, Cisco produced nearly $10.5 billion in operating cash flow against a market cap of just $85 billion. Best of all, the company has a net cash hoard of $28.8 billion, more than a third of its market cap.

Or … does it?

Well, here's where we uncover Cisco's parlor trick. Investors love focusing in on the following lines of Cisco's balance sheet:

Line Item

Total (in Millions)

Cash and Short-Term Investments $43,367
Long-Term Investments $912
Total Debt $16,749
Total Net Cash $27,530

Source: Capital IQ, a division of Standard & Poor's.

Finance articles of all kinds love to report that after deducting debt from cash, Cisco has nearly one-third of its value in cash. On the surface, that does look like an amazing deal. After considering that Cisco generates free cash flow of $9.25 billion per year and subtracting out cash, it trades for just 6.1 times trailing free cash flow.

However, that cash balance isn't quite what it seems. Cisco holds about 90% of its cash outside the country, and it would be subject to heavy taxation if brought back stateside. During the most recent company conference call, CEO John Chambers said of the company's overseas cash holdings:

Now moving on to our balance sheet, we did close the quarter with a total of cash, cash equivalents, and investments of $43.4 billion. [Figure excludes long-term cash holdings.] That was up $3.1 billion from last quarter, which included net additional borrowings of $1.5 billion, as well as continued strong operating cash flow of $3 billion. Of this balance, $4.6 billion was held within the U.S. at the end of the quarter.

That might sound trivial until you realize that repatriating this cash can trigger the upper 35% U.S. tax rate on those funds. That means the company could face a tax bill of up to $14 billion on its current cash holdings.

Here's what Cisco's cash balance throughout time looks like netted out, after considering overseas tax implications.

Source: Capital IQ, a division of Standard & Poor's.

This is, I admit, an oversimplified overview, with all cash assumed to be subject to a 35% repatriation tax. Still, you can see that Cisco's total cash after considering taxes hasn't increased substantially over the past half-decade. And its use of increasing debt creates an operating leverage of sorts: The more debt it raises and the more cash comes from overseas, the more deceptive its total cash hoard is. Even if Cisco's total cash amount is soaring, the net cash available to stockholders after considering additional taxes is barely budging.

So much more to buy
In any event, the tech world is rife with crazy cheap values without considering Cisco as an investment. For the following options, I again oversimplified to assume that all cash would be subject to a 35% repatriation tax, and I also eliminated stock-based compensation from cash flows.


Adjusted Net Cash

Adjusted Free Cash Flow

Adjusted EV/FCF

5-Year Compounded Growth Rate

Cisco $12,032 $7,620 9.6 5.2%
Apple (Nasdaq: AAPL) $42,748 $22,254 11.7 62.6%
Microsoft (Nasdaq: MSFT) $25,487 $22,081 8.3 10.1%
Google (Nasdaq: GOOG) $19,176 $7,106 19.1 37.7%
Intel (Nasdaq: INTC) $9,128 $8,665 12.2 9.2%
Hewlett-Packard (NYSE: HPQ) ($14,032) $8,454 10.3 20.6%

Source: Capital IQ, a division of Standard & Poor's. All cash figures in millions. Adjusted net cash taxes all cash at 35% tax rate. Adjusted free cash flows subtract stock-based compensation.

This comparison is actually generous to Cisco, since its rivals generally hold less cash held overseas. My "adjusted cash" measure is therefore overly harsh on them. For example, Apple holds only about 60% of its cash overseas.

You can see that Cisco is comparable in value to many of its peers, but it's hardly in "deep value" territory as many articles would lead you to believe. In fact, the most undervalued name in big technology from this analysis is Apple, once you factor in projected growth rates.

Another wrinkle in the analysis
One last point on Cisco's valuation is acquisitions. With the company refocusing on core areas such as switching and routing, you might expect acquisitions to decline in the coming years. But historically, this has been a very acquisitive company. Here's a look at Cisco's cash flows compared against cash acquisitions.

Source: Capital IQ, a division of Standard & Poor's.

Simply put, if a company needs to acquire to grow, its free cash flow is overstated if you don't factor in the cost of those acquisitions. When you consider that Apple has historically been a very unacquisitive company, Apple looks even cheaper in comparison to Cisco than the free cash flow in the table would indicate.

Bottom line
Cisco does have some factors going for it. Even if it is losing share to competitors such as Hewlett-Packard and Juniper (NYSE: JNPR), it still has immense advantages in the routing and switching space. And it pays a dividend, while Apple doesn't. However, if you're looking for a dividend-paying stock in the space, Microsoft looks cheaper and pays a larger dividend than Cisco.

The threats to Microsoft are fairly obvious, such as mobile sales that reduce PC growth and an alternative operating system from Google. But Cisco faces threats, too -- they're just a bit more opaque. In its core market of switching, for example, rivals such as HP have become more competitive. Then there's the cloud. Like Microsoft, Cisco sees opportunity there, but projects such as Open Flow threaten to increasingly commoditize networking in cloud computing and further threaten Cisco's margins.

Despite my concerns, I still own Cisco. Given a proper refocus, I think it can turn the corner -- but I also think the company's "deep value" pedigree is overblown. If you're looking for the best deals in tech, definitely look elsewhere.

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