Networking equipment behemoth Cisco Systems (CSCO) has run into troubled times of late. Cisco had reduced its long-term growth guidance last year and there were fears that it might be losing its business in the emerging markets. Moreover, the resurgence of Alcatel-Lucent (ALU) seems to have further sparked fears among Cisco investors that the company is losing its footing in the market. But is there a turnaround story in sight for Cisco? I don't think so. I will tell you the reasons why I think Cisco is a bad investment, but first let's take a look at the company's business.
Transition in Progress
Cisco is transitioning from selling hardware like most of its peers to selling business outcomes. The company has deployed nearly $180 billion worth of network equipment worldwide and the company wants to leverage this strong install base to create new opportunities.
Cisco's cloud networking platform, Meraki, is also doing very well, growing over 100% year-over-year and more than doubling customers from 4,300 one quarter ago to 9,600 in this quarter. The Meraki and Sourcefire acquisitions continue to perform well and have improved Cisco's position as a leading security company, the only one capable of delivering an end-to-end architectural approach.
Cisco is also focused on delivering value to shareholders. In Q4 FY12, Cisco had committed to return a minimum of 50% of its free cash flow annually through dividends and share repurchases. In fiscal 2013, it returned over 50% of free cash flow, and in the first half of fiscal 2014, it returned more than 150% of free cash flow to its shareholders.
Cisco's board has approved an increase of $0.02 to the quarterly dividend to $0.19 per share, an increase of around 12%, representing a yield of approximately 3.50%. This dividend increase, combined with the anticipated share repurchases in the second half of the fiscal year, would comfortably exceed a return of over 100% for the full fiscal year of its free cash flow.
Why Investors Should Stay Away
But there are certain things that go against Cisco. Personally, I believe Cisco has lost its way under chief executive John Chambers. The company's share price has been almost stagnant in the last 10 years, underperforming the S&P 500 by a huge margin. The rich dividend, which now has a yield of 3.50% thanks to the falling share price, has supported Cisco's share or else it would've plummeted further. In addition, the company has always tried to repay investors by the means of share buybacks and has spent roughly $72 billion in the process.
Cisco has further decided to borrow $8 billion through a bond sale to facilitate share buyback. While bulls may argue it is a good strategy given the low rate of interest, I don't think it will prove to be beneficial. Buybacks are good for investors, but I believe Cisco is in dire need of improving its revenue. The company should use this cash to develop new business and buybacks do not create any kind of new revenue streams, and existing segments are seeing alarming declines in revenue.
Cisco's revenues across all segments are falling and the company can't continue buying back shares forever. The company needs to find new ways to improve its business rather than spending lavishly on buyback programs.
The importance of a growing business can't be neglected as Cisco has fallen prey to its competitors. For instance, the router business was a key segment for the company. However, it has surrendered market share to smaller rivals like Alcatel-Lucent and Juniper (JNPR). Alcatel-Lucent's revenue has grown consistently in the last three years. The effect of an efficient CEO is clearly visible as Alcatel-Lucent has improved significantly in the last one year.
Alcatel-Lucent has witnessed double digit revenue growth under the leadership of Michel Combes and is looking to get profitable on a sustainable basis by 2015. Alcatel's router business has also improved greatly and should continue to grow as the company has tie-ups with many big-name telecom players like AT&T (T) and China Mobile (CHL) for their 4G LTE network development.
Juniper on the other hand, is more exposed to the router business. The company derives nearly 50% of its revenue from routers and even though it is a much smaller company than Cisco, its sales have improved consistently. In fact, the company delivered record revenue of $1.27 billion, up 12% year-over-year, in the latest reported quarter.
Cisco is looking to get better in the long run but it faces imminent challenges. In my opinion, I think Cisco should consider investing in growing its business rather than spending too much on buybacks. The company is facing competition from various rivals such as Alcatel and Juniper, which makes investment in growth initiatives even more important. Cisco had slashed its growth forecast late last year, and this is another reason why investors should stay away from the stock.