Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
Cisco Systems (NASDAQ:CSCO) just reported a fine fourth quarter. Non-GAAP earnings rose 10.6% year over year to $0.52 per share, edging out analyst estimates by a penny per share. Revenue increased 6.2% to $12.4 billion, right in line with Wall Street expectations. In response, the stock plunged as much as 9.6% overnight.
Wait -- what?
Yes, Cisco's stock was punished hard, even though the company more than met analyst targets in the fourth quarter. It's the worst performer on the Dow Jones Industrial Average (DJINDICES:^DJI) index by a wide margin today, even though fellow Dow member Wal-Mart (NYSE:WMT) missed Street targets last night. Sam Walton's megastore empire's shares fell no more than 3.1% on the news.
But Wal-Mart's modest miss was followed up by only slightly lower full-year guidance figures, and it's pretty much business as usual for the retail giant. Trimming Wal-Mart's bangs seems like an appropriate response. Leave radical haircuts to a bigger miss -- or a more miserable forward guidance report.
And that's where the Cisco story is different.
Cisco CEO John Chambers cheerfully told investors that he likes the market trends he sees. "My confidence in our ability to be the #1 IT Company is increasing," he said in the earnings release. The company is reporting record numbers on several important fronts, including quarterly revenue, adjusted earnings, and operating cash flows.
Sounds like a great platform for near-term growth, right? Unfortunately, Chambers undermined that positive view with a string of negatives. But you had to wait for the earnings call to get the whole story. There, Cisco laid out some disturbing details.
In the first quarter -- which is almost halfway done, as Cisco reports full-year results at the tail end of its SEC-mandated reporting window -- sales should grow 4% year over year, give or take a percentage point. The very top of that range only matches analyst expectations, so that's not good news.
Cisco could make up for that weakness with stronger margins, but both gross and operating profit margins are supposed to stay flat. Non-GAAP earnings guidance ends up just below analysts' $0.51 per-share target.
So guidance isn't impressive, but it's hardly worth a 10% overnight share-price drop. But here's the big confidence-buster that's driving Cisco down today: The company is getting desperate.
In that fateful earnings call, Cisco also outlined a huge cost-cutting program that includes about 4,000 job cuts. Cisco's layoffs will reduce its total work force by 5%. Chambers explained this drastic move in stark terms:
What we see is slow, steady improvement, but not at the pace we want. I'm real pleased with our momentum in the market. It just is not growing as fast as we need
What's going on?
Cisco has become too heavy in the middle, and it mostly plans to cut out the beer belly of superfluous middle management. That's supposed to accelerate profit growth in the coming years.
Layoffs are often seen as a good move. For example, memory chip producer Micron Technology (NASDAQ:MU) is implementing a similar 5% workforce reduction right now, and that stock soared 8% higher on the news. But Micron's layoffs were an expected side effect of the recent closing of its Elpida acquisition. Investors just like to see Micron making the tough decisions that will make the game-changing deal a profitable one, too.
There's no such massive buyout deal to account for Cisco's layoffs. Rather, investors are reading this move as a sign of weakness. Has the company really become bloated again, despite John Chambers' promise two years ago to simplify and refocus his business model?
For what it's worth, Wall Street analysts generally disagree with the price drop. Cisco stock saw several analyst upgrades last night, not to mention reiterated "buy" ratings. Goldman Sachs sees a buy-in opportunity, as shares just got cheaper without any company-specific headwinds.
"We view the lack of topline acceleration in the near-term as being more macro-driven than company-specific, and would use the pullback to buy the stock," said Goldman analyst Simona Jankowski.
I think Goldman is right on the money here. Cisco shares have still crushed the Dow in 2013, rising 25% even after last night's brutal haircut. A quick discount should help new Cisco investors build a healthy position in the resurgent networking expert. Nothing in this report changed my positive view of Cisco's long-term prospects, and my bullish CAPScall on the stock stays in place.
That being said, let's keep an eye on exactly where Cisco lets the axe fall. Many companies focus their cost-cutting efforts on the research and development budget, which is a terrible mistake for innovation-driven tech businesses like Cisco. I'd rather see reductions in the sales department or an even-handed cost-reduction across the board.
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