Cisco Falls On Weak Guidance, Remains Acquisitive

Cisco (NASDAQ:CSCO) was able to beat market expectations with its Q1 fiscal 2016 earnings on the back of strong growth in product revenues across geographies. However, the company’s stock declined by over 5% as its guidance for Q2 revenues and earnings were below expectations, citing macroeconomic uncertainty leading to weaker order growth as the main reason. ^[1] Nevertheless, Cisco remained acquisitive during the quarter to bolster its product portfolio and even signed a crucial agreement with Ericsson (NASDAQ:ERIC), which should help its growth in the long run. Also, the company believes that its routing sales, which fell 8% in Q1, can recover in the coming quarters with good order growth and better performance from new platforms. ^[2] From a long-term perspective, routing sales should benefit from Cisco’s elevated focus on security, which can help it fend off competition from white-label hardware.

During the quarter, Cisco’s revenues increased by 4% to $12.68 billion and profits rose 9% to 59 cents per share. This was just ahead of the consensus estimate of $12.65 billion in revenues and EPS of $0.56. The company’s growth was mainly driven by 17% growth in collaboration and 24% growth in the data center space. However, Cisco guided for flat to 2% growth in its revenues for the second quarter, with EPS at 53-55 cents, which was below market expectations. The company mentioned that currency headwinds and lower-than-expected order growth are responsible for its disappointing outlook. However, its performance should improve in subsequent quarters on account of the aforementioned factors, as well as the fact that its deferred revenues grew strongly during the quarter. Deferred revenues for software and subscription were up 36%, and for security and collaboration, they increased 31% and 18%, respectively. ^[3]

We have a $27 price estimate for Cisco, implying a slight discount to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our full analysis of Cisco

Acquisitions,Ericsson Partnership Strengthen Cisco’s Footing

Cisco CEO Chuck Robbins, who took over the role earlier this year, has overseen a string of acquisitions that could help the company bolster its portfolio and unlock growth opportunities. During the quarter, the company completed three acquisitions – OpenDNS, MaintenanceNet and Pawaa Software – to bolster its standing in the security, service, software and cloud domains. While OpenDNS provided Cisco with advanced threat protection technology, Pawaa Software complemented the company’s security portfolio with software to prevent data leaks at the hands of trusted users. The acquisition of MaintenanceNet, which was previously a vendor for Cisco, brought its software in house.

The company announced four more acquisitions in the recently concluded quarter, which are expected to close in Q2. Cisco announced its intent to acquire UK-based cybersecurity company Portcullis, for its extensive portfolio of security services including web application assessments, network penetration testing, and incident response. The company’s other acquisitions include ParStream, Lancope, and 1 Mainstream in the security, data analytics and video domains. ^[2] In addition, Cisco recently announced a partnership with Ericsson, which could reportedly bring in $1 billion in incremental revenues for each company by 2018. The deal could potentially help Cisco cater to a larger audience given that Ericsson does business in over 180 countries.

Routing Sales Can Improve Going Forward

Cisco’s routing sales increased just 1% last fiscal year due to growing competition from white label hardware. During the first quarter of the current fiscal year, the division’s sales fell an alarming 8% to $1.8 billion, which the company mainly attributed to the timing of the large deals in Q1. However, it mentioned that order growth was solid, as orders for newly introduced routing platforms were up in triple digits. Also, Cisco has a few new routing launches lined up for the coming weeks, which can help it improve routing sales in the near term. ^[3]

For the long run, the company’s strategy of bolstering its security portfolio can help it suppress competition from white-label hardware and subsequently improve routing sales. Although software defined networking has gained significant traction, its negative impact on Cisco’s proprietary protocol hasn’t been as extreme. This is attributable to the fact that Cisco has progressed well on improving its network security and has also adapted to changes in the networking environment. During its earnings call, the company mentioned that its security revenues increased 7% (much faster than routing and switching), with an acceleration in the shift from hardware to software. During the quarter, Cisco integrated Sourcefire malware capabilities into its firewalls and routing platforms, and added 2,000 AMP (advanced malware protection) customers, bring the total customer count to 8,000. ^[3]

With acquisitions focused on security, Cisco will be able to bundle its hardware with better software products, which should ultimately boost its routing sales. The company is trying to build an architecture in every business division with hardware, software and service integrated to make it more convenient for customers.

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1. Cisco shares slide 5% as guidance disappoints, CNBC, Nov 13 2015 [↩]
2. Cisco Reports First Quarter Earnings, Cisco, Nov 12 2015 [↩] [↩]
3. Cisco’s Q1 Fiscal 2016 Earnings Transcript, Nov 12 2015 [↩] [↩] [↩]