Cisco Systems (Nasdaq: CSCO) is starting to look like the next Microsoft (Nasdaq: MSFT) to me. And no, I don't think that's a good thing.
Microsoft joins the establishment
There was a time when Microsoft qualified as a "growth story." Investors saw it not just as a safe, reliable place to park their money, but also as a company that they were confident would deliver market-beating returns. That was back in the day when the PC industry was booming, when product lines such as its Windows Server operating system and Exchange email platform were major growth areas, and when there was still hope that Microsoft could dominate the Web.
But today? Microsoft's following among growth investors is about as strong as its following with open-source software fans. The PC industry has matured, and Windows Server and Exchange are no longer the growth engines they once were. As for its Web efforts? Not only have Microsoft's attempts to challenge Google (Nasdaq: GOOG) and Yahoo's (Nasdaq: YHOO) leadership in the search and portal markets, respectively, come up short, but the company's Online Services division has also turned into a giant cash-burner, reporting a $2.25 billion operating loss for 2009.
Meanwhile, a variety of competitors have been chipping away at Microsoft's Windows and Office cash cows. Apple continues to steadily gain share in the high-end PC market. Linux has gained a following both as a prime-time server operating system and as a PC operating system for netbooks and low-cost systems targeted at developing nations. And with more than 20 million active users and counting, Google Apps is quickly transforming from a mere nuisance to a real threat in the productivity-software space.
None of these competitors will deal a crippling blow to Microsoft, not with Windows and Office being as entrenched as they are in the corporate and consumer worlds. But they do have the net effect of damaging Microsoft's growth potential. In fact, combined with the maturing of its most valuable markets and the lack of a compelling growth engine, Microsoft is now the quintessential "establishment" tech company. Its shares can perform well when the broader tech sector is performing well, but you can't hope for anything special over the long run.
Adjusted for dividends, Microsoft's shares have delivered a 3% return over the past two years, nearly in line with the Nasdaq's 2% rise. I don't think that's a coincidence.
Is Cisco going the same way?
Those arguing that Cisco will remain a growth story going forward tend to emphasize that Internet traffic growth is still soaring, and that Cisco, as the world's largest vendor of the switches and routers that shuffle all of this traffic, will grow along with it. But once you factor in the huge annual price declines that happen for networking gear working at a particular speed, Internet traffic growth by itself gets you only so far. For example, while Cisco's Visual Networking Index forecasts global Internet traffic growth of 45% for 2010, and 44% for 2011, research firm Infonetics is forecasting 23% and 19% price declines this year, on a per-port basis, for networking equipment based on the gigabit and 10-gigabit Ethernet technologies that many enterprises and carriers use.
And while Internet traffic growth is still pretty strong, it looks as if traffic growth on the corporate networks that Cisco has long dominated is a little slower. With J.P. Morgan recently estimating that more than 60% of Cisco's switch revenue and 30% of its router revenue still comes from the enterprise area, this isn't something to gloss over.
Competitors take share
Meanwhile, Cisco's competitive standing in the switch and router markets is shakier than it might look at first glance. Research firm Dell'Oro estimated that Cisco's Ethernet switching share fell 4% last year to 67%, and further losses seem likely.
Hewlett-Packard (NYSE: HPQ) has been slowly picking up ground in the low end of the switching market with its ProCurve line of products, and its pending acquisition of 3Com should both allow it to sell more costly gear and turn HP into a major player in the fast-growing Chinese market. Juniper Networks' (Nasdaq: JNPR) EX line of switches saw 164% annual revenue growth last quarter, and it could be taking advantage of the challenges that Cisco's faced in transitioning to its new Nexus switch line. And Force10 Networks, which recently filed for an IPO, has made a name for itself selling high-capacity switches for data centers.
In the router market, Cisco's share on the high end has held steady for a while at around 55%, and its recently announced CRS-3 router should keep the company on solid ground. But in the faster-growing market for "edge" routers sold to service providers, which now accounts for close to half of global router sales, Dell'Oro estimated that Cisco's share fell by 8% last year to 43%, as Alcatel-Lucent (NYSE: ALU) continued to grow by leaps and bounds. China's Huawei Technologies has also been gaining share.
As with Microsoft, none of Cisco's competitors is going to eat its lunch. The IOS operating system that powers most of the company's gear is close to an industry standard, and to rework an old saying, no one ever got fired for buying Cisco. But also like Microsoft, Cisco's competitors will chip away at its growth potential. And for the time being, Cisco's much-hyped growth initiatives, such as its TelePresence platform for high-definition videoconferencing, and its UCS server platform, are too small a part of the company's business to make a big impact.
Over the past five years, Cisco's shares have risen by about 47%, soundly outperforming both Microsoft and the Nasdaq. But the mere 4% gain they've had over the past two years is a whole different story -- one that's probably a sign of things to come.
