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Investment Overview for Cisco (NASDAQ:CSCO)
Below are key drivers of Cisco's value that present opportunities for upside or downside to the current Trefis price estimate for Cisco:
Cisco Switches Market Share: With a market share of close to 75%, Cisco has a dominant position in the switching market.The market size for the bottom layer switches is more than the combined size for routers (core, enterprise and edge) at an estimated $18 billion for 2012. Due to its longstanding customer relationships and dominant position in the industry, we see very little declines in Cisco's market share and expect it to remain above 70% throughout our forecast period. However, if increasing competition eats away at its market share and causes it to decline to about 60% by the end of our forecast period, we could see a potential downside of about 5% to our price estimate. On the other hand, if Cisco leverages its dominant position and wide enterprise reach to further bolster its share to 85%, there could be an upside of a similar nature to our price estimate for Cisco.
Cisco Edge Router Market Share: We forecast Cisco's share in the edge router market to moderately decrease from an estimated 53% in 2012 to 50% by the end of our forecast period. However, there could be a downside of about 2% to our price estimate if Cisco were to see its market share decrease to 40% by end of our forecast period. On the other hand, if the market share were to increase to around 60% there could be a similar minor upside.
Enterprise Router Market Share: We forecast Cisco's share in the enterprise router market to only moderately decrease from an estimated 83% in 2012 to about 80% by the end of our forecast period. Given its high share in this segment, rising competition can have a negative impact on our price estimate for Cisco. There could be a potential downside of about 1% to our price estimate if Cisco were to see its market share decline by 1o percentage points by the end of our forecast period.
For additional details, select a driver above or select a division from the interactive Trefis split for Cisco at the top of the page.
Cisco designs and sells networking and communications technology and services. It creates networking equipment such as switches and routers used primarily by businesses and Internet service providers to route data such as emails, videos, files and other digital communication. For example, an email that you send to a distant friend travels through various switches and routers made by companies like Cisco, Juniper and Alcatel-Lucent along the path to its destination.
Over the past four years, Cisco has had close to 75% market share in the market for Switches, which is expected to be about $18 billion in 2012. The switching market comprises of both Bottom Layer Switches and Top Layer Switches. Bottom Layer Switches are the most prevalent types of switches found within networks and used for basic routing of data within the network. The market for Bottom Layer Switches alone is bigger than the overall router market.
In addition to networking hardware, Cisco provides maintenance and support services to its customers to help them fix problems that occur with networking equipment. Cisco's network service revenues and profits are dependent on the installed base of Cisco switch and router equipment.
Of the various router segments, Cisco has a bigger presence in the enterprise router market owing to its longstanding relationship with enterprises and their willingness to let one vendor handle all aspects of their network, as opposed to service providers. Cisco commands more than 80% of this market and we expect the company to see only a slight decline in its market share, going forward. Enterprise Routers are used by medium and large businesses for their own data routing needs. Core Routers and Edge Routers, on the other hand, are used by Internet Service Providers to route data traffic from network to network.
Escalating Mobile Data Traffic Driving Router and Switch Sales
A study released by Cisco in early 2013 estimated that global mobile data traffic grew by 70% in 2012 and had at least doubled each year over the previous four years. Going forward, it expects to see the figure grow 13-fold between 2012 and 2017. Most of that rapid growth will be fueled by the burgeoning demand for video, which is expected to account for almost two-thirds of all mobile traffic by 2017.
Growing penetration of mobile devices such as smartphones and tablets is driving the demand for mobile data through the roof, causing wireless service providers to look for cost-effective ways to upgrade their networks in order to support and monetize the growing traffic. Cisco, which has a dominant position in the networking market, is positioned well with its strong customer relationships to benefit from the growing demand for network equipment in the long run.
Alcatel Lucent's re-entry into core router space
Historically, Cisco and Juniper have had a virtually duopolistic control over the core router market, with a more than 80% combined market share at all times. However, that is now threatened by the re-entry of Alcatel Lucent in the core router space in 2012. Despite not having a core routing solution until now, Alcatel Lucent has steadily climbed the edge routing charts from being just an entrant in 2003 to surpassing Juniper as the number 2 vendor in the industry in 2009-10. With about 24% market share of the edge routing industry, Alcatel Lucent has done well to find a place in many networks and can now use that as a leverage to push its core routers as well.
Also, armed with an end-to-end solution, Alcatel Lucent can now compete with Cisco for many businesses in the edge routing industry that prefer such solutions, hurting Cisco's edge routing market share even further.
Hardware to software shift in networking
There is going to be an industry wide shift in demand from hardware networking solutions to software-based ones in the long run. This poses an interesting challenge to traditional hardware-based players such as Cisco and Juniper. VMware, for example, is a threat considering its virtualisation expertise and its recent acquisition of Nicira, a software-based networking company. Cloud-computing solutions are also driving this trend. Cisco recently launched its own cloud-based routing and WAN optimization platform for the enterprise, called the Cisco Cloud Connected Solution to address the changing trend.
The Bring Your Own Device (BYOD) movement is causing corporates to increase their allocation of IT budgets towards enhancing network security. As employees bring their own mobile devices such as the iProducts as well as Android based smartphones and tablets to work, enterprises feel an increasing need to bolster their network security to effectively manage and support all devices while mitigating the threat of an outside attack. Addressing the BYOD movement presents Cisco with an opportunity to increase security revenue as well as improve the demand for its routing and switching solutions.
IP Data Convergence
In recent years Cisco has increasingly focused on the convergence of IP data through digital video, IP telephony and web conferencing. Cisco has positioned itself to benefit from the ongoing transition of TV viewership to all digital services (e.g. digital cable) and the evolution of business communications from fixed line communication to IP based, video and web conferencing enabled communication.
Trefis Forecast Rationale for Routers Gross Profit Margin
Gross Margin represents Gross Profit as a percentage of Revenue. Gross Profit is determined as Revenue minus Cost of Goods and Services Sold.
Cisco's gross profit margins have tended lower in the last few years as the networking giant started aggressively pricing its offerings in order to combat low-cost vendors such as Huawei as well as new entrants such as Juniper. While the company's efforts at preserving market share have largely been successful, the margins have come down as a result. From around 65% in 2008, Cisco's product gross margins have fallen to about 61% in 2012.
We expect the margin decline to continue, albeit at lower than historical rates, as Cisco launches newer upgrades and benefits from the cost-cutting measures of the recent restructuring initiative.
Our forecast is based on the following three factors:
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- Cisco regaining focus on core products
- Instead of diversifying itself into 30 new businesses, as earlier envisioned, Cisco announced in mid-2011 that it is restructuring to increase focus on driving its core networking business.
- Greater focus on the core switching business will help Cisco not only decrease costs but also improve its sales mix of higher-margin newer products, going forward.
- This may stop margins from declining at a rapid rate but increasing competition from vendors such as Huawei and Juniper will continue to weigh on margins.
Emerging markets could lower margins further
- Cisco is increasing its focus on the high-growth emerging markets of China and India.
- Since customers in these economies are more sensitive to price, Cisco's margins could fall as an increasing proportion of revenues come from these regions.
- Cisco's large scale and reach gives it economies of scale that is hard to match for its competitors
- Cisco is by far the largest communication equipment provider globally and is industry leader in virtually all the businesses it operates in
- It has a presence in all major markets globally and its operations are not limited to US or Europe only
- This wide scale and reach enable it to negotiate better terms from its suppliers
- For example, it is believed that Cisco gets far better terms from its Application Specific Integrated Circuits (ASICs) suppliers than any of its competitors
- Further, Cisco ships by far the largest number of units
- Costs are apportioned over a larger number of units and hence per unit cost works out to be lower.
Cisco's sales and distribution network is the best in the industry, enabling it to build customer relationships and charge a premium for its products
- Cisco has by far the best sales execution in the industry
- As mentioned above, it also enjoys an excellent brand image
- These factors ensure that Cisco is considered to be a trusted and reliable brand by both enterprises and service providers
- This enables Cisco to continue to charge a premium on its products
- For example, enterprises, which value network reliability much more than costs, willingly pay a premium for a reliable Cisco product over a cheaper product from another manufacturer.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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