The tech firm, Cisco (CSCO, Financial), recently came into the news with the recent firing of 6,000 employees or around 8% of the workforce, which casts a grim image of the company. This would be the largest layoff Cisco has conducted since 2011, and within the past three years, the company has removed nearly 20% of its staff. Since 1993, Cisco has acquired a huge list of companies, the count currently standing at 144. It has grown its revenue from $700 million in 1993 to $40 billion to date. But in the quarter that ended July this year, Cisco reported a drop in revenue by half a point to $12.4 billion, and net income also came down by 1 point to $2.2 billion. Investors are a bit worried whether Cisco still remains a promising brand in the near future. Let’s dive in and find out the breakup in Cisco’s revenue and what future its operating segments hold so that investors can make a calculated decision.
The revenue breakdown
Services account for nearly 10% of Cisco’s revenue. Most of the telecom companies nowadays make more from services than from hardware sales. On the contrary, this segment is not as diversified as it should have been for Cisco. Instead, the company makes around 42% of its overall revenue from the switches business but this sector is also slowing moving to the red zone as margins are under immense pressure from lower cost rivals.
The other two major operating segments, routers and advanced technologies portfolio, contribute to around 20% and 10%, respectively to Cisco’s total revenue.
The datacentre business which includes the UCS systems and related Nexus switches, continues to be the bright spot for the company in terms of revenue generation power, but their margins are likely to get narrower due to growing competition.
Recently a story published in Networking world spoke of two senior Cisco officials leaving the company to join VMware (VMW, Financial) and Hewlett-Packard (HPQ, Financial). VMware remains a major rival of Cisco, and this management shift could be treated with a note of caution. News sources have claimed that such shifts were happening as there is a lot of internal politics and management inertia which is leading to loss of important core company personnel.
Operational cash flow usage
Since 2008, Cisco has spent close to $40.8 billion on stock repurchases and has promised to improve the dividend pay-out and advocate share buyback utilizing up to 50% of its operating cash flow. Though this looks favorable for the investors, it brings up the question whether a growth company would pay out most of its operational cash flow to investors for rewarding them, or is it a tactic to keep the earnings per share stable when earnings are being hit by several external factors?
Since nearly 69% of Cisco’s operational cash flow has been used for repurchases since 2004, this has led to EPS increase due to continuous decline in shares outstanding. Investors should be cautious and should not be drawn only by such investor rewards if they want to stay invested in the company from a long-term horizon.
Outlook for Cisco stock
Cisco seems reasonably priced and has an impressive free cash flow to sustain its growth pace. The shares currently yield 3.2%, and the company does have the financial flexibility to increase the quarterly dividend and share repurchases for the next couple of years.
The company expects SDN, security, services and Internet of things to be its core drivers in the coming future. The rest of Cisco’s portfolio has lost their lustre and there are huge gaps in the offerings for OSS/BSS, deployment and integration solutions.
Most of the high end cloud services are delivered by channel partners like VMware and Accenture (ACN, Financial) capturing most of the service value, and Cisco almost does not feature in this space. In a recent Forbes article, it has been posted that even in the Internet of things, Apple (AAPL, Financial) has a sevenfold lead over Cisco. So Cisco does have its set of challenges in the market.
Concluding thoughts
The company is being hit from all ends by competitors trying to encroach its space in almost every operating segment. Yes, the stock holders need to remain cautious of their holdings at this juncture. But hopefully Cisco will see greener pastures in the near future and as it still rewards investors and makes them smile, it’s not a bad proposition to hold the stock as a viable investment option.
