Cisco Surfs To $24 Riding Digital Content Tsunami

John Chambers is down but not out

Following Cisco’s earnings release, traders lopped 16% off of its share price as a result of lower revenue guidance going into next year. Cisco competes with Juniper, Alcatel-Lucent and Tellabs in the routing and switching businesses.

The plunge led to fears that the tech sector is stalling, which we feel is unjustified at this point though we acknowledge the slowdown in public spending is concerning.

However we feel that major trends benefit Cisco such as the proliferation of digital content and the shift to cloud computing. We maintain our optimistic view on Cisco’s medium to long-term prospects and keep our price estimate of $24.04, which is around 25% ahead of current market levels.

Public Spending Concerns

Cisco’s drop sent off alarm bells. This was the biggest drop in Cisco’s stock since 1994 ^[] and was primarily triggered by concerns surrounding a slowdown in public spending.

Facing budget deficits, the U.S., Japan and some Central European countries have reduced their IT spending more than expected. As the economic recovery continues to be sluggish and governments are burdened with debt, Cisco will face short-term challenges in terms of its share in switches and router market.

If its market share drops from our current estimates of 72% through the forecast period to 66%, this reduces our estimate by 2.5%.

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Explosion in Consumer Digital Content

The company estimates that Internet traffic will increase more than four-fold by 2014, amounting to 64 exabytes per month ^[]. This will inevitably require better networks including routers and switches that can handle a high amount of data. These structural tailwinds support Cisco’s core switches and routers businesses which account for 27% and 15% of our price estimate respectively.

This growth is also fueled by increasing affordability of devices like computers as well as the proliferation of smartphones and tablets that promote data usage. According to Internet World Stats, the number of global internet users grew by 13% in 2009 amounting to 1.7 billion ^[].

Double-digit growth at a global scale implies the addition of close to 220 million Internet users annually. Cisco estimates that global IP traffic increased by 45% in 2009 amounting to 15 exabytes per month ^[]. Moreover, the number of online videos viewed in 2009 increased by a whopping 120% amounting to 300 billion ^[].

Growth of Cloud Computing

Cloud service models provide users or enterprises with computing infrastructure and eliminate the need for locally managed software and computing resources, such as physical storage. Some of the major cloud service providers include Amazon, SalesForce and Google.

We expect this area to grow rapidly. According to IDC, the IT cloud services market is expected to grow from an estimated $17 billion in 2009 to $44 billion in 2013 ^[]. As more computing shifts to the cloud, Cisco will benefit from requirements of handling additional IP data and security services for the cloud.

You can see the complete $24.04 Trefis price estimate for Cisco’s stock here.

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Cisco Plugs Into Network Security Business, Stock Eyes $24

Taking bigger steps into security

Cisco’s revenues from sales of network security products like Virtual Private Networks (VPNs) and firewalls have risen from an estimated $1.1 billion in 2005 to around $1.9 billion in 2009. ^[]

Though Cisco is not as dominant in this area as the routers and switches business, it still commands a respectable 35-40% market share. ^[] Cisco’s primary competitors like Juniper, H-P, Check Point and McAfee are also seeing revenue growth, contributing to the overall growth of network security market.

While we expect Cisco will continue with its gradual growth trend in network security sales, the Trefis member community predicts a slight decline. We currently have a Trefis price estimate of $24.04 for Cisco’s stock, about 24% above the current market price of $19.44.

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Growing Demand for Network Security

Cisco’s revenues in network security products are tied to its network routers and switches business. Customers generally tend to buy an entire solution to meet their network infrastructure requirements, and Cisco has capitalized on its ability to deliver both core network equipment and security products.

The network security market slowed in 2009 mainly due to restricted spending by companies due to the recession but is now beginning to pick up. According to Infonetics Research, network security appliance and software revenue increased 7% worldwide between Q1 and Q2 2010, totaling $1.4 billion.

The three top vendors saw firm sales growth in the most recent quarter: Juniper (+12%), Check Point (+9%) and Cisco (+8%). Cisco was held back in recent quarters by supply constraints on some of its components that are fixed now. ^[] This will allow it make up for lost ground vs. its competitors.

The Trefis community forecasts that the network security revenues will increase from $1.8 billion in 2010 to $2 billion by 2016 while Trefis estimates an increase from $2.1 billion to $3.1 billion during the same period. The lower community forecast corresponds with a slight decrease in price estimate.

Our complete analysis for Cisco’s stock is here.

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Cisco Plugs Into Network Security Business, Stock Eyes $24

Taking bigger steps into security

Cisco’s revenues from sales of network security products like Virtual Private Networks (VPNs) and firewalls have risen from an estimated $1.1 billion in 2005 to around $1.9 billion in 2009. ^[]

Though Cisco is not as dominant in this area as the routers and switches business, it still commands a respectable 35-40% market share. ^[] Cisco’s primary competitors like Juniper, H-P, Check Point and McAfee are also seeing revenue growth, contributing to the overall growth of network security market.

While we expect Cisco will continue with its gradual growth trend in network security sales, the Trefis member community predicts a slight decline. We currently have a Trefis price estimate of $24.04 for Cisco’s stock, about 24% above the current market price of $19.44.

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Growing Demand for Network Security

Cisco’s revenues in network security products are tied to its network routers and switches business. Customers generally tend to buy an entire solution to meet their network infrastructure requirements, and Cisco has capitalized on its ability to deliver both core network equipment and security products.

The network security market slowed in 2009 mainly due to restricted spending by companies due to the recession but is now beginning to pick up. According to Infonetics Research, network security appliance and software revenue increased 7% worldwide between Q1 and Q2 2010, totaling $1.4 billion.

The three top vendors saw firm sales growth in the most recent quarter: Juniper (+12%), Check Point (+9%) and Cisco (+8%). Cisco was held back in recent quarters by supply constraints on some of its components that are fixed now. ^[] This will allow it make up for lost ground vs. its competitors.

The Trefis community forecasts that the network security revenues will increase from $1.8 billion in 2010 to $2 billion by 2016 while Trefis estimates an increase from $2.1 billion to $3.1 billion during the same period. The lower community forecast corresponds with a slight decrease in price estimate.

Our complete analysis for Cisco’s stock is here.

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Cisco Stares Into Traditional Set-Top Box Black Hole But It Just Doesn’t Matter

Johnny doesn't sweat the set-top

Cisco released third quarter results recently with lowered guidance leading us to lower our forecasts and price estimate for Cisco’s stock to $24.04, which is about 23% above current market price.

Cisco competes with Juniper, Alcatel-Lucent and Tellabs in the routing and switching businesses.

We recently published an article discussing how weak public sector demand is affecting Cisco. However, Cisco is also facing dramatic declines in orders from cable providers, especially in set-top box business.

We currently forecast flat market share for Cisco in the set-top box business through the Trefis forecast period. Using our charts, if Cisco were to leave this business altogether by 2016, and market share drops from around 9% to 0%, this reduces our price estimate by 5%.

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North America Set-Top Box Weakness

Traditional set-top box orders from North American accounted for about 50% ^[] of all set-top box orders in the recent quarter and suffered a massive decline of 40% ^[] in Q1 2011 vs. last year.

In addition to slowing spending, lower cost competitors are making significant inroads into this business.

A Need to Worry?

We don’t think that investors should be too much concerned about Cisco’s set-top box business. This business constitutes only about 4.3% to Cisco’s stock based on our estimates. Moreover, the company has stated that it is only witnessing declines in traditional set-top box business while its IP set-top box business is doing well.

As Cisco positions itself better for future by transitioning its business to focus more on new generation set-top boxes, the effect of a decline in the traditional set-top box will be limited.

The key for investors will be to focus on the new generation set-top boxes and the switches and routers business makes up 27% and 16% of Cisco’s value, respectively.

You can see the complete $24.04 Trefis price estimate for Cisco’s stock here.

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Roll With The Cycles, Grab Some Cisco While It’s Cheap Again

Darwin's ideas work in stocks, too

“If I’d known I was going to live this long, I would have taken better care of myself.” – Eubie Blake, American composer (1887–1983)

You cannot underestimate the power of cycles.? They reoccur in nature, business, and financial markets with great regularity.? When we ignore them, cycles seem obvious in hindsight.? Foresight is where you’ll make your money.

Time frames may be different based on secular trends, weather phenomenon, innovations in health care, and government intervention, but generally, what goes around, comes around.? For example, economic booms and busts occurred, on average, every 14 years for 2,000 years.?Beginning in the late 20th?century, they began cycling every seven years as a direct result of government efforts to stimulate economic activity during recessionary downturns.? While they occur more frequently, they’re cycles nonetheless.

Tall Parents Have Shorter Children, On Average
Charles Darwin and his cousin, Francis Galton, were the first to note that tall parents have shorter children, on average, and vice versa.? With Karl Pearson, they studied over one thousand father and son pairs.? Galton termed this phenomenon in nature “regression to mediocrity.”? Since then, the method of studying how one variable leads to another variable has been called “regression analysis.”

Financial market observers see it all the time.? Excessively high prices eventually lead to excessively low prices.? The key to succeeding as an investor is knowing where the excesses are when they’re happening and exploiting them.

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“Joining The Dow Can Be The Kiss Of Death”
In September, Jeff Reeves of InvestorPlace.com conducted research showing that by the time companies have grown to become the recognized leaders in their industries, share prices are inflated.? For example, turning the clock back to March 1999 when the Dow Jones Averages closed above 10,000 for the first time, then crested to 11,000 a few months later, four of the biggest names of the day joined the Dow 30. Here’s how they fared: AT&T (then SBC Communications), down 38%; Intel, down 50%;?Microsoft, down 47%;?Home Depot, ?down 38%.

During subsequent reformulations of the Dow Jones Industrial Average, laggards were replaced with other leaders of the time.? They included Pfizer, Verizon, Bank of America, Cisco, and AIG.? As a group, these stocks have been shellacked since they joined the Dow 30, but along the way they have continued to make a lot of money for anyone who purchased shares when stock prices were excessively low.? Many have tripled off of lows in 2003 and 2009.

The point is this: You cannot fight the power and magnitude of cycles.? They can make or break an investor.? Here’s one stock that appears far too low right now:

Fallen Angels Focus Stock: Cisco Systems? (CSCO, 20.15)

Cisco is the dominant player in the global networking industry.? Shares plummeted more than 16% on ?Thursday following a less than stellar outlook presented by company management.? While management cited near term challenges, we believe the selling has provided an attractive entry point for longer-term investors.

The company has a solid balance sheet, operating profit margins of more than 20% and net margins in the high teens.? Our fair value estimate (based on discounted cash flow analysis) is $30 per share; providing investors with 50% potential upside from current levels.

Gabriel Wisdom and clients of American Money Management LLC, including mutual funds managed by AMM may buy or sell securities mentioned without prior notice.

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