Editor's note: This article was originally published on Dec.
In the past four to five years, investors have been more
squarely focused on the consumer end of the tech landscape, bidding
up shares of
and others. But on the business end of high-tech, the big
winners haven't been such industry leaders. Instead, mostgains have
come from small, but growing software and data-storage providers.
But this theme may be upended in 2013, as one of the most dominant
companies in the enterprise space regains its mojo.
I'm talking about
Cisco Systems (Nasdaq:
, which has had little to show investors during the past five
Blocking and tackling
Although thestock chart may give the impression of a company slowly
losing relevance, nothing could be further from the truth. Cisco's
operational performance has been quite solid in recent years,
especially when compared to stumbling giants such as
Computer Sciences (NYSE:
, and especially when compared to more direct networking
competitors such as
Juniper Networks (Nasdaq:
. Consider that Cisco has generated a whopping
in cumulative free cash flow during the past five
But Cisco can be taken to task for being a little too content to
simply squeeze out cash from a largely mature business.
Indeed, shares fell out of bed in the summer of 2011 simply because
investors could no longer see a long-term path to growth. A number
of the company's recent acquisitions had failed to deliver promised
growth, and Cisco's end markets -- most notably in government and
telecom -- weren't looking all that perky.
Yet in recentquarters , management has begun to talk about a
sharper game plan that will likely help solidify
Cisco's role in so many markets. The plan involves a number of
small steps that are unlikely to lead to explosive sales growth,
but should fuel a steady expansion in profit margins and
a more linear trend of profit growth.
Here are the five small steps that should add up to solid gains
for Cisco's shareholders in 2013.
Going where the action is
Cisco is typically thought of as a networking giant, known
for producing the software, switches and routers that run
corporate and telecom data networks. But thanks to heavy
spending on research and development and certain
acquisitions, Cisco is now very well-positioned for industry
leadership in mobile computing, cloud computing,
video-delivery services, network security, web conferencing
and network storage. No other vendor in the world
can offer clients this comprehensive suite of
offerings, a key consideration when information technology
managers worry about the interoperability of various
technology components in their corporate ecosystem.
"The market is moving to buying solutions rather
than buying standalone boxes, playing to Cisco's core
strength," notedanalysts at Merrill Lynch.
A rising focus on software
|The company has set an ambitious target of doubling
therevenue it derives from software in the next five years.
This, in turn, should lead to a rising take rate for its
expanding suite of service offerings. This is a page right
out of the
playbook. Cisco's CEO John Chambers is
surely aware of IBM's 100% stock pricegain during the past
five years, as investors have come to embrace Big Blue's
You can't blame Chambers for a bit of IBM envy. IBM carries
similar margins today, but its enterprise value-to-sales
(EV/Sales) ratio is 40% higher than Cisco's. That's why
emulating IBM is a wise move.
Furthering the IBM analogy, Chambers understands that IBM's
focus on long-term service contracts leads to much smoother
revenue and profit streams. The company aims to boost service
revenue from a current 21% of the sales mix to more than 25%
within three years.
Squeezing out costs and other margin boosters
Cisco has at times been accused of a bit of "porkiness." The
company has grudgingly embarked on a few major layoffs in its
history, but nobody would call Cisco a lean
enterprise. In recent meetings with analysts, however,
Chambers has discussed plans to trim down and/or reap
synergies where possible in coming quarters. This helps
partially explain why he expects operating profits to grow
3-4 percentage points faster than sales growth in the next
few years. (The rising mix of software is anotherfactor ).
Chambers also understands that profit gains need to be linear
if they are to be applauded byWall Street (another
lesson taught by Big Blue). The fact that Cisco's operating
profits fell by $2 billion in fiscal (July) 2009, rose by a
similar amount in 2010, fell again in 2011 and rose anew in
2012 is a clear impediment for investors that crave
Tapping emerging markets
Chambers now spends a considerable amount of time on the road
in Latin America and Asia. He's directed his sales force to
treat these markets as a top priority. The timing is good as
many of these markets are now increasingly home to large
domestically-grown companies, and not simply the foreign
divisions of firms like
. Emerging markets currently represent about $9 billion in
annual sales (20% of the entire sales base), though Cisco
aims to boost that figure by 10% annually in the next three
to five years. To get there, Cisco is developing lower-cost
solutions for these price-sensitive markets.
Free Cash Flow = Buybacks
Any discussion of Cisco has to touch on the prodigious free
cash flow and the long run of share buybacks they have
fueled. The share count has already fallen from 6.8 billion
in fiscal 2004 to 5.4 billion at the end of 2011, and
considering management's plan to spend 60% of
future cash flow on buybacks and dividends, this
trend should continue.
Risks to Consider:
To augment growth, Cisco has signaled plans to pursue a fairly
hefty acquisition in coming quarters, and such deals can
sometimes spook investors.
Action to Take -->
Even with all of these growth-inducing steps, Cisco is only
likely to boost sales in the mid-to-upper single digits each year,
while per-share profit growth is unlikely to exceed 10%. But by
delivering these kinds of gains in a steady linear fashion,
investors are likely to reward this stock with an
ever-higher multiple . When you include Cisco's massive $33
billion net cash pile, this becomes a low-multiple stock with a
fairly low level of embedded expectations. This means 2013 should
represent a fresh perspective for this one-time highflyer as growth
-- David Sterman
P.S. -- Stocks like Cisco are part of a group of companies
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David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of CSCO in one or more of its "real money" portfolios.
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