Cisco Systems Earnings Preview – The Balancing Act Continues

As Cisco Systems is expected to announce their earnings for the first fiscal quarter of 2015 today, the company faces a long list of challenges in order to meet or beat the expectations put on the company by analysts and investors, but their biggest challenges will be long-term, where open networking, SDN and the cloud are the biggest market growth areas. Cisco Systems is expected to report $12.17 billion in revenue and an EPS of $0.53 based upon Thomson Reuters consensus estimates. This is in comparison to an EPS of $0.53 on $12.08 billion in revenue, indicating an expectation of flat YoY profitability.

Slow and Steady

For Cisco Systems’ first quarter of their fiscal 2015, the company could continue their overall pace with slow, steady growth in both revenue and profitability, as a result of many competitive factors balancing one another out. Cisco Systems’ switching business continues to occupy about 1/3 of the company’s overall revenues and will likely do so coming into this quarter. Their routing business also oscillates between being 16 and 17% of revenue, so that’s very likely going to stay the same as well. Their video and collaboration businesses both fluctuate between 8 and 9% of revenue and are expected to pretty much remain within those percentages. Additionally, the remaining business units are expected to essentially perform the same as they have over the course of the past four quarters in FY14, which pretty much flattens out most expectations for Cisco Systems revenue and profitability.

Challenges to Short-Term Stability

Cisco Systems appears to be a very stable and sound company to investors, especially considering that they have a very strong dividend that amounts to a 3% annual yield. This will keep many long term investors happy and less likely to jump the boat on short term bad news. But there are still some worrying factors that Cisco Systems needs to address long term, especially going into fiscal 2015 which could affect margins and profitability.

One worrying spot for Cisco Systems is in the regional high-growth markets in BRIC countries where Cisco Systems saw order decline by double digits. The biggest and most concerning decline for Cisco Systems was in China where they saw order decline over 20% over the same quarter y-o-y. This is thanks to a combination of public sentiment against American networking companies and homegrown companies like Huawei taking advantage of these political conditions to grow their market share. Thankfully for Cisco Systems, the developed markets like the US have rebounded in their spending and as a result have compensated for most of the losses in BRIC countries, but there’s no knowing how long that will last or if the reductions will increase. The question in the U.S. is pricing, where I have anecdotally heard stories of Cisco giving away equipment to thwart advances from open networking or SDN vendors.

New Technology And New Approach Needed to Drive Growth

For Cisco Systems, the primary growth factor needs to be from new technologies and new products. Those include Cloud and SDN, both of which could be potential growth spots for Cisco Systems but also potential losses if competitors are able to gain traction. With the introduction of their new CRS-X and NCS routers, they are able to grow high-end revenue and profitability and really push the company forward. The problem is that these two new products are still a small portion of the company’s overall revenue and need to increase at a greater rate to help the company’s growth. They are also very much optimized for “proprietary”.Cisco_logo.svg

Cisco Systems also has the Nexus 9000 switches which are part of the company’s ACI SDN strategy, but require better industry adoption in order to compete with other SDN platforms that could compete with Cisco’s already existing switching hardware. This is especially true considering how many companies are interested in the spine and leaf configurations, open networking and SDN solutions that are tailor fit for their enterprise. Cisco Systems will struggle to adopt a strong open or SDN product line as it will cannibalize their current switching offerings, especially when you consider that switching makes up for around 1/3 of the company’s revenue.  Very few companies have made this turn away from proprietary systems when they have been successful in it for so long.  Just look at the troubles IBM is going through which could very well mirror Cisco in a few years.

They’ve also acquired Metacloud, which could potentially help them grow their cloud offerings, especially within the OpenStack area of private cloud. Metacloud allows for Cisco Systems to expand upon their cloud offerings and to improve on their hybrid cloud vision of mixing private OpenStack private clouds with already existing public cloud deployments that Cisco Systems dubiously calls the “Intercloud”. The challenge here is scale and Cisco doesn’t have it when it comes to the cloud. HP and IBM are light years ahead of Cisco in the cloud game which Cisco entered late.

Potential Stumbling Blocks

Some of Cisco Systems’ biggest stumbling blocks may come by the way of their own lack of rapid innovation and adjustment to market factors. The company has already been working on reducing their operating costs and trimming in ways to improve profitability while simultaneously giving back to investors in the form of dividends and buybacks.

Cisco Systems is a company with a lot of business units but not many with high growth, they’ve completely removed themselves from consumer products in an ugly exit and haven’t made any major acquisitions since the purchase of NDS Group. NDS Group (now Cisco Videoscape) was acquired by Cisco Systems 2 years ago, for $5 billion and even at that time, there was very solid case for the company as they provide a very stable and solid source of revenue and profit. However, with the increase of on-demand video services and direct to consumer online streaming, there are possibilities that NDS could see their business shrink over the next few years. The biggest challenge here are lower margin products and technologies that are IP-based yet provide a stellar quality of service regardless of the lower price points.

Cisco faces immense challenges from competitors like Dell, Huawei, Hewlett-Packard and Juniper who continue to pressure Cisco Systems’ core businesses and are always looking for ways to grow in an industry where open networking and SDN is becoming the hottest new thing and everyone wants to hop aboard. No, neither open networking or SDN is widely deployed in the enterprise today, but is in the public cloud, and as we have seen for the past decade, everything migrates from public cloud to the enterprise eventually.

It will just be interesting to see if they are able to buck the trend of some of their competitors that have already reported this quarter. Or then again, they could resort to more share buybacks and dividends to keep investors happy. But like IBM, who recently abandoned their EPS promise, Cisco could very well need to do the same thing.