The Tech Tsunami
The major change coming involves a shift from hardware laden data networking to software-defined networking (SDN). The SDN is a remarkable set of complex processes about how data gets routed across networks. Instead of stringing together several hundreds of servers and applications that makes data centres of this hi-tech age work efficiently, the SDN works by separating the control plane from the data plane so that control is centralized and moves out of the router. What that means is that the era of IP networking where Cisco is king currently will soon give way to the SDN technology. The SDN technology is basically software driven. It is capable of managing and moving data efficiently. So, the question is, does this imply that tough times await Cisco and other major network equipment producers? How much concern should investors show to this looming monumental change?
Whither Cisco in the Emerging Scenario?
That the SDN technology is an existential threat to Cisco is not out of point but the company is much aware of the potential threat and as usual, I expect Cisco to embark aggressively on a series of acquisitions of relevant companies that could help it regain its control of the industry leadership in the eventuality that the SDN technology start to take root firmly. Already, the company recently acquired Composite Software, a specialty company in data visualization, as probably one of its strategies to build a synergy in the SDN technology and retain its firm grip on the network equipment industry where it has been a major player. In Cisco ONE (Open Network Environment), Cisco has already embraced SDN and because SDN will take time to take root globally, Cisco can hope to take the lead in the emerging market scenario.
Currently, by value, Cisco controls 59% market share of the global IP switches supplies. It also controls 53% of the routers supplied worldwide and 52% of data center tools.Cisco has always been a forward-looking tech business, and the company believes that acquisition of strategic businesses helps it expand its business operations into new technology areas and markets where it does not already maintain comparative advantage. Therefore, it appears unlikely that such a company can’t wait to be negatively affected in the face of an obvious monumental tech storm that is glaring even to lay people and investors.
Cisco’s Valuation and Outlook
Until we see the emergence of a new order in this tech sector, Cisco remains the industry leader, and the company is doing quite well operationally when compared with its competitors. In the last three years, Cisco’s revenue has grown at about 7% which is much more than its peers. In addition, Cisco’s operating margin released recently for the year end July 2013 was phenomenal at 23.7% when Juniper’s recently released margin was below 11%.
Really, hardware components like switches and routers constitute about 50% of Cisco’s revenues which could be impacted when SDN technology gains ground but as highlighted earlier on, Cisco should by then be better placed as a software services company rather than a hardware company that it is currently. Once that is achieved, Cisco should be able to maintain its level of profitability going forward.
To cap it all, analysts at Goldman Sachs believe that Cisco has the wherewithal to transform from a ‘’box’’ company that it is currently to a platform company which SDN technology represents. In addition, Goldman Sachs’ analysts hold Cisco on its ‘’conviction buy’’ list because of the strong fundamentals of the company despite the threat of a revolution in its tech industry.
I’m long Cisco and would recommend it to value investors without any reservation.