Cisco Transformation Could Take Several Years

Core businesses are seeing their market potential dwindle by the quarter

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May 23, 2017
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Shares of Cisco (CSCO, Financial) have lost more than 10% since the company reported better-than-expected third-quarter earnings. Beating earnings and revenue forecasts for the third quarter made no impression on the market as a dour fourth-quarter outlook from the company raised concerns about Cisco’s short-term growth prospects.

The world’s largest networking company reported third-quarter earnings per share of 60 cents and revenues of $11.94 billion while Wall Street expected earnings per share of 58 cents and revenues of $11.89 billion.

Cisco’s reported $11.94 billion was 1% lower than the $12 billion the company posted last year. Sales for the first three quarters of the current fiscal total $35.872 billion compared to $36.609 billion last year, a decline of 2%. Cisco is expecting sales to decline by 4% to 6% during the fourth quarter, much higher than the decline experienced during the first nine months of the current fiscal.

The growth of the cloud industry has dented the future prospects of Cisco’s networking business, and the company has embarked on a transformation process, pushing into IoT, Data Centers, Cloud and Security in its drive to become a software and services company. During the fourth quarter of 2016, the company announced plans to restructure the workforce by slashing 5,500 positions or 7% of its global workforce. Now, the company has expanded the program by announcing another 1,100 job cuts.

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Cisco makes a lot of money from Switching and NGN Routing. During the third quarter these two segments accounted for 46% of overall revenue. The problem both these segments are facing is that the IT world is steadily moving toward third-party-managed infrastructure. As enterprises around the world find third-party providers to handle their infrastructure, it reduces the need for networking equipment, thereby trimming Cisco’s potential market size.

Cisco knows this, and that's the reason it is trying to move from hardware to software and services. The company ploughed nearly $3.7 billion into buying networking and application monitoring company AppDynamics, and the acquisition of MindMeld, an artificial Intelligence platform, is expected to close during the fourth quarter of the current fiscal.

Cisco is cutting its workforce while also adding new segments through acquisition, but the results are yet to show up in its financial statements. The transformation will not be a short and swift one, and it could easily take several years to yield results.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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