Here are the five small steps that should add up to solid gains for Cisco’s shareholders in 2013.
1. Going where the action is
Cisco is typically thought of as a networking giant, known for producing the software, switches and routers that run corporate and telecom data networks. But thanks to heavy spending on research and development and certain acquisitions, Cisco is now very well-positioned for industry leadership in mobile computing, cloud computing, video-delivery services, network security, web conferencing and network storage. No other vendor in the world can offer clients this comprehensive suite of offerings, a key consideration when information technology managers worry about the interoperability of various technology components in their corporate ecosystem. “The market is moving to buying solutions rather than buying standalone boxes, playing to Cisco’s core strength,” noted analysts at Merrill Lynch.
2. A rising focus on software
The company has set an ambitious target of doubling the revenue it derives from software in the next five years. This, in turn, should lead to a rising take rate for its expanding suite of service offerings. This is a page right out of the International Business Machines Corp. (NYSE:IBM) playbook. Cisco’s CEO John Chambers is surely aware of IBM’s 100% stock price gain during the past five years, as investors have come to embrace Big Blue’s linear growth.
You can’t blame Chambers for a bit of IBM envy. IBM carries similar margins today, but its enterprise value-to-sales (EV/Sales) ratio is 40% higher than Cisco’s. That’s why emulating IBM is a wise move.
Furthering the IBM analogy, Chambers understands that IBM’s focus on long-term service contracts leads to much smoother revenue and profit streams. The company aims to boost service revenue from a current 21% of the sales mix to more than 25% within three years.
3. Squeezing out costs and other margin boosters
Cisco has at times been accused of a bit of “porkiness.” The company has grudgingly embarked on a few major layoffs in its history, but nobody would call Cisco a lean enterprise. In recent meetings with analysts, however, Chambers has discussed plans to trim down and/or reap synergies where possible in coming quarters. This helps partially explain why he expects operating profits to grow 3-4 percentage points faster than sales growth in the next few years. (The rising mix of software is another factor). Chambers also understands that profit gains need to be linear if they are to be applauded byWall Street (another lesson taught by Big Blue). The fact that Cisco’s operating profits fell by $2 billion in fiscal (July) 2009, rose by a similar amount in 2010, fell again in 2011 and rose anew in 2012 is a clear impediment for investors that crave linearity.
