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Data Center Acquisition Helps to Stabilize Growth for Cisco in 1Q14

September 15, 2013 | About:

On September 10 Cisco announced its acquisition of WHIPTAIL which will contribute to revenue in its Data Center business segment. The acquisition follows the company’s fourth quarter announcement to decrease its global workforce by 5% and reduce its Q1 2014 revenue guidance. Both signs that growth could be stalling for the company.

In its 4Q 2013 earnings announcement Frank Calderoni, executive vice president and chief financial officer, stated the company’s plans to reduce its global workforce by 5% in order to streamline its business operations.

In the past two years, we have managed the business with discipline and focus. In order to execute on the portfolio investment and operational efficiency opportunities that we see in FY ‘14, we are rebalancing our resources with a workforce reduction, which will impact approximately 4,000 employees or 5% of our global workforce. (Source: Seeking Alpha Transcript)
In the 4Q 2013 earnings announcement management also stated forward-looking revenue growth guidance of 3%-5% from Q1 2013 to Q1 2014, slightly lower than the projected long-term revenue guidance of 5%-7%. Both of these announcements appear to have caused some decreased confidence for investors resulting in a slight devaluation of the stock.

In an interview at the Deutsche Bank Technology Conference, Gary Moore, Cisco’s president and chief operating officer, discussed how the acquisition of WHIPTAIL will contribute to the company’s growth strategy. According to Moore, the acquisition will strategically help Cisco to enhance the performance of its server offering by incorporating solid state memory. Through integration with existing technology used in Cisco’s Unified Computing System (UCS) strategy, WHIPTAIL’s scalable solid state memory systems will help improve the overall performance of the company’s server product offerings. This integration will help create an even greater competitive advantage for the Data Center’s Unified Computing System products.

The WHIPTAIL acquisition is valued at $415 million and is expected to close in Q1 2014. Revenue from the integrated UCS offering will contribute to the Data Center business segment which has been a key growth area from the firm. In Cisco’s 4Q 2013 earnings comments John Chambers, chief executive officer, highlighted the growth already occurring in the Data Center segment.
Our Data Center business is a tech improved point. We successfully drove the transition to a converged architecture and you see this in our Data Center results, a 2 billion plus business in five years growing revenue over 40% year-over-year in the most recent quarter and we’re not stopping. (Source: Seeking Alpha Transcript)
While Data Center represented a small portion of the company’s product revenue in 4Q 2013 it showed the highest product segment comparable quarter growth rate and also the highest three-year compound annual growth rate. In 4Q 2013 Data Center revenue was $593 million, a 43% increase from 4Q 2012. In the segment, fiscal year 2013 revenue was ten times 2011 revenue levels ending 2013 at 2.1 billion versus 196 million at the beginning of 2011. The acquisition of WHIPTAIL and its system integrations with Cisco’s UCS will likely ensure a continued pace of revenue growth for the company’s Data Center business segment.

The acquisition of WHIPTAIL will also have a trickle over effect on the negative outlook for the workforce reduction. It will bring onboard 80 engineers as well as other additional employees adding to the onboarding and integration of employees in the company’s fiscal year 2013 acquisitions. While a 5% workforce reduction overall has seemed to signal a potential slowdown for Cisco, the underlying employee integrations from the 11 previous acquisitions occurring in 2013 show a strategic reprioritization of resources in key growth areas for the company that should have a positive effect on the bottom line.

For investors, the acquisition of WHIPTAIL and integration of its employees is good news for the stock’s valuation. It means a potential increase in product revenue growth for the company and a more efficient use of resources. Overall, the integration of solid state memory within the USC strategy will help Cisco continue to improve its competitiveness in the server market which should in turn help the company to meet its 5%-7% long-term revenue goal.

With these factors considered the stock appears to have increased upside potential for long-term investors seeking technology investments. For the near-term it is slightly undervalued, trading at $24.28 versus its one-year price target1of $25.50.

1 The price target is derived from Bodie, Kane and Marcus’ intrinsic value formula. The intrinsic value formula discounts the stock’s projected one-year future cash flow by the risk-free rate on the one-year Treasury note and includes adjustments made for specific market assumptions including the stock’s beta and market risk premium.

Disclosure: No holdings.

This article is provided on behalf of QuantShare. QuantShare is a trading software company that provides desktop trading software applications for serious stock, futures and Forex traders. Get your free trial here.

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