As Internet continues to open new markets and opportunities, current business models need to adjust to new customer preferences. In other words, communication companies are presented with the chance to develop new products and technologies to better serve new and old customers alike. Let us see what prospects Harris Corporation (HRS) and Cisco Systems (CSCO) hold, and how they evolve in order to serve new and highly demanding customers.
Being the Leader Is Not Easy
Headquartered in San Jose, Calif., Cisco Systems is the leading provider of IP-based networking and other networking products. The multinational business holds the most diverse portfolio for data, voice and video transportation, and its fourth-quarter report has beat many analysts’ estimates. The company’s current market positioning, innovative prowess, product range, growth initiatives and expected growth at end markets make it a very competitive rival for industry peers.
Cisco Systems had a weak 2012, but rebounding signs are visible on higher revenue and lower operating expenses. At the same time, the company has developed the Unified Computing Systems, described as a revolutionary blade server system based on x86 architecture that is transforming data centers. The introduction of the UCS has been very well timed amid the current adverse economic environment, since one of its most attractive features is cost reduction.
Another two important initiatives that improve prospects for the company are: market adjacencies and acquisitions. Management plans to use core competencies supplemented by acquisitions to exploit opportunities in more than 30 adjacent markets. So far, the strategy has been successful in the smart connected communities, small business and smart grids areas. With respect to acquisitions, Cisco has bought Meraki, Cloupia, Cariden, BroadHop and Intucell, in addition to 11 smaller companies. While the first five have strategic operations, the last 11 were meant to increase the customer base.
Cisco holds a very strong balance sheet, while indicators continue to improve year-ove-year. Currently trading at 13.2 times its earnings, packing a 58% discount to industry average, the stock is undervalued. I remain bullish about the stock because of its innovative introduction that has forced industry peers to quickly develop new partnerships and complete acquisitions to avoid falling behind. The great number of gurus buying the stock for the first time, and small reductions on those already holding important positions, like Jeremy Grantham, are an evidence of the great moment the firm is going through.
Diversify from U.S. Dependence
Based in Florida, Harris is an international communications equipment producer. The firm is divided among five segments, each of which is independent from the other. The company has been hard hit by U.S. reductions of defense budget. And, the effects have materialized on less radio procurements domestically, and delays for international orders. However, the stock price continues to rise and is trading close to the 52-week high.
On the upside, Harris has an important backlog and pipeline. The first stands at $1.34 billion, while the second is speculated to add up to $6.2 billion. Hence, the firm’s forward outlook is promising, especially after winning a three-year contract with the U.S. Air Force for the provision of IT-related products and services. Moreover, the company is expected to sign four contracts with commercial airliners for DCIS equipment, after closing a deal with the Federal Aviation Association worth $150 million.
Harris is wrestling with financial difficulties due to cuts in the U.S. Defense Budget and lower sales for its high-end products. Management’s response to offset the negative trend continues to be the divestiture of non-core businesses and a strong shares buyback policy. At the same time, the acquisitions of CapRock Communications, Global Connectivity Services and M/A-COM have pushed growth, while enhancing the competitiveness and entering the very profitable public safety market.
Finances for Harris are moderate because debt remains high and revenues have not totally recovered. Currently trading at 14.3 times its earnings, packing a 55% discount to the industry average, the stock is undervalued. Joel Greenblatt, the guru holding the largest number of shares, increased his position by 32%. However, I do not share his optimism and prefer to remain on the sidelines as other gurus holding large positions. I would like to wait until recent acquisitions are fully integrated and management develops a long-term strategy to reduce dependence from the U.S. Defense Department.
Cisco holds the best market positioning; Harris, on the other hand, holds an important market position, but has difficulties in Europe and lacks a rival to Cisco’s UCS. Last, Harris faces two grave difficulties: dependence on the U.S. defense budget, and failure to integrate acquisitions successfully. For all of this, I prefer Cisco Systems over Harris.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.