Cisco Is Worth $23.50 As Restructuring Pays Off

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Cisco (NASDAQ:CSCO) announced solid Q4 FY 2012 results last week as revenues grew more than 4% and operating income 14% over the same period last year. The networking giant gained revenue market share in both core and edge routing at the expense of rival Juniper Networks (NYSE:JNPR) – a good sign that its turnaround efforts in shoring up key routing and switching businesses are paying off. However, macro-economic concerns surrounding the Euro debt crisis continued to weigh on network spending in Europe, which accounts for close to 20% of Cisco’s revenues. This was however largely offset by sales in the U.S. which showed signs of returning to strength and the emerging markets in Asia-Pacific which showed a strong y-o-y growth of 12%. Enterprise, one of Cisco’s key strongholds, grew 6% y-o-y despite the ongoing macro-economic concerns.

The company also added 1,400 employees during the quarter, half of which were recruited in emerging markets. This came on the back of the 1,300 job cuts that were announced last month. Cisco is restructuring its operations in order to cut costs in areas that are not its core focus, making the organization leaner and more efficient. At the same time, it is bolstering its routing and switching businesses in high growth markets through strategic job hires.

We believe that the company is going in the right direction since its core networking products contribute almost 35% to our estimated  $23.50 fair value for Cisco, with cash contributing another 25%. With the company’s turnaround plans gaining ground, Cisco’s stock has risen almost 15% in the past couple of weeks and is now about 25% below our price estimate.

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See our full analysis on Cisco

Margins stabilizing

The cost cutting and restructuring seems to be paying off for the company not only in terms of market share gains but also operating margins which are stabilizing at >20% levels, after having fluctuated widely in recent quarters. This increases confidence in the management’s guidance of achieving a long-term operating margins in the mid-20s and increasing profits at a faster pace than revenues. Cisco has already realized $1 billion of the total $1.1 billion of severance charges related to the workforce reduction program it had announced in July 2011, and the operating margins should remain fairly stable from hereon. With savings achieved on the operating side, Cisco will be able to make aggressive price cuts to compete better with low-cost rivals and gain even more market share.

Fundamentals drive Cisco’s future earnings

As for top-line growth, we believe Cisco’s fundamentals remain solid due to the ongoing transition from wired to wireless networks, the burgeoning usage of data on both mobile and wired networks as well as a strong demand for cloud-computing routing solutions on the enterprise side. The company recently debuted its virtual cloud-routing and WAN optimization platform under the Cisco Cloud Connected Solution brand to enable businesses that are increasingly looking to move their applications to the cloud at a low cost. (see Cisco’s Worth $23 On Cloud Foray And Enterprise Strength) Its recent move to acquire NDS Corp was made to drive device-agnostic video consumption and increase the demand for its routers and switches among service providers that are looking to monetize the booming data demand. (see Cisco’s NDS Acquisition Taps Video Demand To Boost Network Equipment Business)

While the macro-economic environment may continue to be challenging (the company remained cautious in its guidance for the future), we believe that Cisco has executed well on its turnaround plans so far and is well-positioned with its new-found focus to gain even higher ground going forward. (see Cisco’s Post-Earnings Crash Makes The Stock Look Incredibly Cheap) 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.  However, 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.

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