Cisco Systems (NASDAQ: CSCO) needs to move its portfolio to remain competitive in the context of a rapid consumption of cloud computing services induced by the coronavirus. The fiscal results released this week in the fourth quarter showed that legacy network companies remain a key drag for their performance. Because of these important challenges, the stocks trade at modest valuation multiples. Should investors take this opportunity and bet that the tech giant will succeed in adapting its portfolio?
Challenging results
Cisco posted better-than-expected fiscal results in the fourth quarter, but the year-over-year 9% drop in revenue to $ 12.2 billion remains weak. More importantly, the decline of the topline confirmed a significant contrast between the company’s cloud computing and its legacy activities.
As usual, management did not deliver the individual performance of each product, but CEO Charles Robbins mentioned some strong spots during the August 12 calls. He said, for example, that the collaboration tool Webex and the monitoring solution AppDynamics were growing strong revenue. Cloud security also strengthened the company’s security segment, which grew 10% to $ 814 million.
In contrast, the core infrastructure platform segment, which includes legacy network hardware such as routers and switches, fell 16% to $ 6.6 billion. The company’s uniform communication platform also penalizes the company’s results.
In the short term, Cisco’s overall performance is unlikely to improve, as management expects revenue to fall by 9% year-on-year to 11% in the fiscal first quarter, ending October 31.
Indeed, the coronavirus pandemic has in part contributed to the decline in the company’s legacy networking companies, as some customers delayed investments in data centers and local area networks (campus) to create remote work opportunities for their employees. But some difficulties seem deeper, because Cisco’s portfolio does not fully understand the opportunities that cloud computing represents for tech vendors.
As a result, management announced a new phase in the transformation of the company.
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Switch to products or services
During the call for earnings, Robbins announced, “We will accelerate the transition of the majority of our portfolio to service delivery.”
That represents a major shift for the company. Management communicated the percentage of revenue currently delivered if a service is not communicated, but it is safe to assume that it corresponds to a share of 51% of the total submission software of 12 to 12 months (TTM) and representing services (the rest is hardware).
And even if CFO Kelly Kramer said the company will already be offering many as-a-service offerings by the end of 2020, this transformation will span several years, as it will also have to include its large portfolio of network hardware.
Thus, you must take into account the implementation risks associated with such a decision.
The company will rebalance its research and development expenditures, which have totaled $ 6.3 billion in the last 12 months, to drive this transformation. But it remains to be seen whether Cisco will succeed in these efforts against high-growth, cloud-native specialized competitors such as the video communications specialist Zoom video communication, the oversight outfit Datadog, and the cybersecurity player CrowdStrike.
Even with $ 14.8 billion in cash, cash equivalent, and investments in the sheer multiple debt at the end of the last quarter, Cisco was able to continue with transformative acquisitions to accelerate its transition. But it would be worth paying for such transactions, as many tech stocks have jumped to airy ratings in the last several quarters.
Judgment
Because of these uncertainties, Cisco stock looks reasonably valued with TTM business value to sales and price-to-earnings (P / E) ratios of 3.6 and 17.0, respectively.
In addition to its risky – but necessary – shift to as-a-service solutions, the company remains exposed to the long-term tailwinds of new technologies representing 5G, Wi-Fi 6, and 400G.
In addition, in the last four years, the company kept its non-GAAP (adjusted) gross margin to 65%, compared to 65.5% one year ago, which suggests that it maintains its price power. Also due to the large scale, the operating margin remained high at 33%, up from 32.6% in the previous quarter. And management announced the company to save $ 1 billion annually, which will support these high margins during their transformation.
However, given the modest appreciation of the company, the market does not take into account potential upside. Thus, investors looking for exposure to cloud computing at a reasonable price should consider buying Cisco stock.
