Should Cisco Split?

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Hewlett-Packard‘s (NYSE:HPQ) recent announcement that it will split into two companies and eBay‘s (NASDAQ:EBAY) decision to spin off PayPal have led to renewed discussions about the possibility of splitting Cisco (NASDAQ:CSCO) into separate entities to drive growth. The proposition is interesting, as Cisco’s current structure has often been criticized for being too complicated to make quick decisions and effectively compete against smaller players in the current dynamic business environment. [1] [2]

The company’s stock has also under-performed compared to competitors and the market in general, with its share price reporting growth of about 7% in the last five years, compared to IBM‘s (NYSE:IBM) stock appreciation of over 54%, Microsoft‘s (NASDAQ:MSFT) 80% and the Dow Jones Industrial Average (DJIA) witnessing an increase of over 70% in the same period. While this may not be a standalone reason to argue against the company’s policies and structure, it certainly warrants a discussion on whether Cisco could have done better. In this article, we look at the possibility of splitting Cisco into separate companies and how it could impact the company’s growth potential.

We have a $27 price estimate for Cisco, which is about 10% ahead of the current market price.

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Cisco’s Business Transition

Cisco is a global networking giant providing products and services to the communication and information technology (IT) industries. It is a leader in the enterprise routing, network switching and wireless LAN markets, and is also a major player in Internet Protocol (IP) telephony and blade servers. Cisco currently has eight business divisions focused on the design, manufacture and sale of different networking products, services and solutions. These divisions are: Switching, Next-Generation Network (NGN) Routing, Collaboration, Data Center, Security, Wireless, Service Provider Video and Other Products.

However, it is important to understand that over the past few years, there has been a significant transition of Cisco’s business from selling individual products and services such as routers and switches, to selling them as part of integrated architectures and solutions to clients. This has also brought about a marked change in how Cisco markets its offerings to customers. Earlier this year, the networking giant announced that instead of selling a number of individual products, it will bundle them into four different tiers of suites and market them as Cisco ONE Essentials, Cisco ONE Foundational Elements, Cisco ONE Advanced Application Services and Cisco ONE Advanced Security Services.

Although aligned under the same Cisco Open Networking Environment (ONE) developer platform for software-defined networking (SDN), each of the packages serves distinct use cases and can be licensed out on a suite-by-suite basis. Even though the company continues to sell products on an individual basis to customers who prefer it, it believes that the products themselves will assume less importance over time as it promotes bundled licenses instead. The new strategy is initially targeted at the three enterprise domains of data center, enterprise WAN and access networks, but Cisco plans to eventually transition to a similar licensing model for service providers as well.

Splitting May Not be the Best Move

Looking only at the company’s business divisions, it looks promising and simple enough to separate the hardware and software components of Cisco’s business to help the company to drive growth in the data center, cloud and virtualization domains. However, as we have mentioned above, the changing business environment is not so much about individual products or hardware/software, but about integrated architectures and solutions. Therefore, security, software and cloud systems are likely to be as important in a networking solution provided to a customer as a network switch or a router. In addition, there are definite cost and revenue synergies to be realized with all components of an integrated networking solution being designed, manufactured and sold by the same company.

An “intact” Cisco also stands to benefit from its existing customer relationships and industry partners. Having entered the market earlier than most rivals, the networking giant has built its market position on the back of long-standing customer relationships and a sticky enterprise base that is mostly reluctant to replace existing Cisco hardware with rivals’ due to the huge scale of transition that they would have to undertake. Cisco can take advantage of this enterprise stickiness with its Application Centric Infrastructure (ACI) SDN offering.

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Notes:
  1. Split today, merge tomorrow, The Economist, Oct 7 2014 []
  2. The Script for Corporate Splits via H-P, EBay and Gannett, WSJ, Oct 6 2014 []