Cisco’s (NASDAQ:CSCO) recent product refreshes could help it defend its market share in key routing and switching categories, justifying the rally its shares have seen since the start of the year. The networking giant made a few key product announcements this month, unveiling the latest version of the top-end of its router portfolio, the Carrier Routing System-X (CRS-X), as well as boosting its enterprise network offering with new Nexus and Catalyst switches. It is also meeting the growing threat of Software-Defined Networks (SDNs) head on with a new application-centric networking architecture, called Cisco One, that can provide enterprises with more open, scalable and easily programmable networks while keeping Cisco’s position within these networks relevant. The new architecture will help Cisco avoid hardware commoditization by tightly linking the software programmability of network infrastructure to Cisco’s custom-built hardware and hardware-specific operating systems.
In terms of sheer performance as well, Cisco’s new switches and routers pack quite a punch. While the high-end CRS-X core router is almost 3 times as fast as its predecessor, the CRS-3, the new Nexus 7700 switch has about 2.5 times the throughput of the Nexus 7000 and takes about 33 percent less rack space. With the macro-economic environment slowly improving, we expect carriers and enterprises to gradually loosen their purse strings on product refreshes in order to better cope with the surging data traffic coming from mobile devices and cloud services. In anticipation, Cisco’s shares are up over 25% this year.
We maintain our $27 price estimate for Cisco, about 10% ahead of the current market market price.
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Need for scalable and programmable networks
With data needs burgeoning, the networking world is undergoing a paradigm shift. Enterprises and service providers are demanding more network programmability and flatter architectures that decouple many network functions from the hardware and allow them to be centrally administered by software controllers. This not only decreases physical complexity but also makes networks more accommodating to merchant silicon and open source software. The ensuing commodification of hardware however endangers the traditional business model of networking vendors such as Cisco that have relied on hardware complexity to drive product margins. Cisco’s SDN strategy seeks to ward off this threat by developing premium hardware in the form of programmable ASICs (application-specific integrated chips) that can not only work with existing open source standards such as OpenFlow but also new ones as they emerge.
At the heart of this network transition is the need to support the surging demand for data from enterprises as well as mobile device owners. The proliferation of smartphones is already causing mobile data traffic to grow exponentially, and the advent of high-speed LTE networks is likely to feed appetite for mobile data consumption even further. According to a recent Cisco VNI report, mobile data traffic grew 70% in 2012 and is expected to grow at a CAGR of about 65% over the next five years. ((Global Mobile Data Traffic Forecast Update, 2012–2017, Cisco, February 6th, 2013)) Despite some lingering macroeconomic concerns, the broader transition to mobile and the cloud continues to be strong, and we see companies requiring product refreshes to manage this huge traffic efficiently.
Overall, we believe that Cisco is executing well on its turnaround plans and is well-positioned with its new-found core focus to gain higher ground going forward. (see Cisco’s Q3 Earnings Finally Light A Fire Under Its Long-Undervalued Stock) The company’s dominant market position as well as aggressive price cuts have helped it gain market share from rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far and could help it even further when the concerns subside. Alcatel Lucent’s recent foray into core routers poses a downside risk for Cisco seeing as the former is #2 in edge router market share – a position of strength that it can effectively leverage to provide an end-to-end solution to its customers. But Cisco’s recent CRS-X launch should help mitigate that risk to some extent.