How Will Strength In Cisco’s Product Dynamics Impact Its Valuation?

Cisco (NASDAQ:CSCO) reported its Q2 results on February 13, beating consensus expectations on revenue and EPS. The company’s demand momentum appears to be driven by end user business demand, likely making it sustainable over the medium term.

We have a price estimate of $54 per share for Cisco, which is around 15% higher than the current market price. Our interactive dashboard on Cisco’s Price Estimate outlines our forecasts and estimates for the company. You can modify any of the key drivers to visualize the impact of changes on its valuation.

Cisco’s Q2 results carried the strength seen last quarter. What was interesting to note was the relative momentum that Cisco seems to be building across segments. Some Q2 highlights are below:

• Total revenue grew to $12.4 billion (+7% y-o-y) coming in closer to the higher end of the guided range of 5-7% in Q1.
• Infrastructure Platforms revenue grew to $7.1 billion (+6% y-o-y) on the back of double digit growth in campus, double digit growth in wireless from Meraki and Wave2. Routing was weak due to pressure in the service provider segment.
• Applications revenue revenue grew to $1.5 billion (+24% y-o-y). The momentum from previous quarters  is continuing due to the rapid adoption of unified communications, telepresence, and AppDynamics.
• Security revenue grew to $658 million (+18% y-o-y) driven by identity and access, advanced threat, and unified threat management products.
• Service revenue grew to $3.1 billion (+1% y-o-y)
• Subscriptions as percentage of software revenue increased to 65% (vs 54% y-o-y)
• Federal Government: In anticipation of an expected shutdown, owing to their relationships with Cisco, many of the departments had pulled forward their orders, leading to an order acceleration for the company in the government segment.
• Cisco’s board increased its buyback program to $24 billion from $9 billion earlier and also increased its quarterly dividend by 6% y-o-y
• Management guided for 4-6% y-o-y growth for Q3

We note two specific takeaways from Cisco’s results:

• Subscription revenues have been growing, with management firmly resolved on increasing the software component of its business.
• Customers appear to be enthusiastic about the company’s security products, given how Cisco has been able to leverage its acquisitions to enhance the value of its core architecture. This is a marked change in sales conversations from a couple of years back, when Cisco had to educate customers on potential challenges.

Excluding China, where the local players have a major advantage, Cisco’s execution and resulting growth validates management’s thesis of adoption starting in its customer base. We expect Cisco’s relative insulation from cloud spending (and the ensuing slowdown), coupled with the company’s products becoming non-discretionary, to help boost cash flows.

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