Headquartered in San Jose, Cisco Systems is the world’s largest hardware and software supplier within the networking solutions sector and is a bellwether for the industry. The infrastructure platforms group (55% of sales) includes hardware and software products for switching, routing, datacenter, and wireless applications. Its applications portfolio (11%) contains collaboration, analytics, and Internet of Things products. The security segment (6%) contains Cisco’s firewall and software-defined security products. Services (27%) are Cisco’s technical support and advanced services offerings. The company’s wide array of hardware is complemented with solutions for software-defined networking, analytics, and intent-based networking. In collaboration with Cisco’s initiative on growing software and services, its revenue model is focused on increasing subscriptions and recurring sales.
The Potential Opportunities
With COVID-19 changing nearly every business, Cisco has new potential opportunities that could accelerate its trajectory.
COVID-19 causing a pause, but growth should return possibly even stronger
While COVID is causing customers to pause, the longer-term impacts could be a positive for the networking industry. More remote workers, more remote video, and a more clouddriven business worldwide creates more demand for networking. Industry estimates continue to see growth for the medium term; datacenter networking is estimated to grow over 10% the next five years to over $40bn annually. As a leader in networking, Cisco should be able to grow with the market, but execution is important. Consensus expectations are for a 2% revenue decline in F21, followed by 4% growth in F22.
Applications and Security Groups could drive growth
Applications (11% of revenue) and Security (6%) have been seeing significant investment by Cisco. Apps and Security are outside the core hardware business, but leverage Cisco’s large install base of equipment. Moving toward more Applications and Security is critical to Cisco’s push for more subscriptions and recurring sales; moving away from product cycle driven revenue. Acquisitions in these areas should continue to supplement internal R&D efforts. In F4Q20, 51% of revenue was from software and services, which hit the company’s three-year target of 50% by F20. CEO Chuck Robbins said on the August earnings call that, “Security continues to be a top priority for our customers, particularly in this distributed digital world.”
As CPU’s continue to improve performance, more and more of the comm equipment industry will likely be driven by software. SD-WAN is a major element of Software Defined Networking (SDN). SDN provides agility, flexibility, and visibility for workloads that are now distributed across multiple clouds. Security is also becoming more software than hardware. Cisco has underperformed in network security over the years, but it still has a chance to be a leader in the space if it can leverage its dominance in networking hardware. This software taking over networking trend will likely continue for years. Note that the Cat9k comes with embedded software that can be upgraded for a price.
M&A could accelerate, possibly becoming more important to Cisco’s growth
Cisco has been buying up technology companies for decades, but this could accelerate as the pace of technology development continues to accelerate. COVID’s impacts have also made some R&D of less interest (e.g., campus) vs. others (e.g., remote access and security). In early 2016, CSCO acquired cloud based IoT SaaS company Jasper Technologies for $1.2 billion. In 2017, it was the much-discussed cloud monitor AppDynamics for over $3.2bn. In 2018, it was cloud contact center software maker BroadSoft for $2.2bn, SD-WAN provider Viptela for $500mn, and Duo Security for $2.4bn. In 2019, Cisco acquired silicon photonics maker Luxtera for high-performance networking optics.
Huawei concerns could provide upside to consensus expectations
Huawei passed Cisco in the service provider market in C2Q20; 36% vs. 33%. The lower prices of Huawei where effective but security concerns are starting to have a material impact. Extreme Networks cited a recent win at a SP where Huawei was just dropped from consideration. Cisco could regain the lead in SP as more SPs move away from Huawei and longer term start to replace installed Huawei equipment.
Although there are numerous favorable tailwinds, there are also headwinds that must be navigated and overcome. The company has a long operating history, and there are a variety of externalities and issues that have been problematic, but nonetheless many believe that is the reality. Some of the highlighted obstacles include the following:
- It is obvious, but external economic factors, elections, geopolitical issues, pandemics, etc. can all negatively impact demand for any product or service and Cisco is no different. On the August earnings call, the company said it would cut costs (more than $1 billion annualized) as COVID has impacted many customers. The company had its first yearly revenue decline in three years (down 5%). This could make for easy year / year comparisons, but COVID could also continue to have negative impacts.
- Arista has effectively owned the cloud networking market for a few years and there have been expectations that Cisco will start to make some inroads when the cloud titans move from 100G to 400G. However, multi-vendor networks may be a luxury that a post-COVID world will not support. Microsoft Azure has been on a multi-vendor path, but Microsoft was pausing network purchases even before COVID hit the US. Altogether, this may cause Cisco’s window of opportunity to shrink, if not close completely. While Cisco grew its webscale business double-digits for the third quarter in a row, the revenue level is still not meaningful. The cloud titans will likely continue to be a challenge for Cisco.
- Management changes can be a catalyst for a stock, sometimes positive sometimes negative. The announced retirement of CFO Kelly Kramer comes at a difficult time for Cisco; the company is having revenue challenges and is going to be cutting $1bn in expense over the next few quarters. Ms. Kramer plans to stay on until a successor is appointed.