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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 Services Revenue (As % of Product Revenues)
This represents service segment revenues for Cisco expressed as a % of product segment revenues.
Cisco, like most other equipment vendors, provides maintenance and technical support services to its customers. Typically, these are time-bound contracts and are directly linked to the products Cisco sells to these customers.
Also, since service revenues come from recurring sources, they are typically more steady and recession-proof.
Service segment revenues (as a proportion of product segment revenues) have increased steadily from around 20% in 2008 to about 28% in 2012.
We expect service revenues to continue to increase going forward, but an economic recovery and a wider adoption of Cisco's new product launches to also shore up product revenues at the same time. This should cause the figure to only moderately increase to a little over 28.5% by the end of our forecast period.
Trefis considered the following factor for its forecast:
- Recession proof recurring source of revenues
- A services-based business model is typified by the steady, recession-proof revenues that it brings in from customers due to past contracts.
- During a recession, customers may hold off on purchasing new equipment but will continue to pay for the services they require to maintain existing equipment.
- The recurring nature of this business means that it is impacted to a lower extent by an economic slowdown. Cisco's service business has seen revenues increase at a fair clip over the past few years despite the 2008-09 recession and Euro debt crisis.
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- Limited scope for increase in service charges owing to weakening economy and intensifying competition
- As mentioned above, service revenues are directly linked to product sales and are typically charged for as a proportion of product revenues
- However, customers are unlikely to take very kindly to an increase in service charge, especially as most of them are looking to cut costs themselves because of the weak economy
- Further, intense competition in the space might lead to customers moving away from Cisco in case it tries to push through an increase in price.
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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