Cisco systems (NASDAQ: CSCO) must transform their portfolios to remain competitive in the context of the rapid consumption of cloud services, caused by the coronavirus. Its financial fourth-quarter results released this week show that legacy networking businesses remains a significant drag to its performance. Due to these important challenges, stocks trade at modest multiple valuations. Hence, should investors seize this opportunity and bet that the tech giant will succeed in tweaking its portfolio?
Cisco announced better-than-expected fourth-quarter financial results, but revenue fell 9% year-on-year to $ 12.2 billion is still weak. More importantly, the leading drop confirmed a key contrast between the company’s cloud operations and its legacy operations.
As usual, management doesn’t provide individual product performance, but CEO Charles Robbins mentioned some strong points in the August 12 earnings call. Webex collaboration tools and AppDynamics monitoring solutions have generated strong revenue growth. Additionally, cloud security boosted the company’s security division, up 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 unified communication platform in place also influences the company’s results.
In the short term, Cisco’s global performance is unlikely to improve, as management expects revenue to drop 9% to 11% YoY in the first fiscal quarter, ending. on October 31.
That’s right, the coronavirus epidemic partly contributed to the decline of the company’s legacy network businesses as some customers delayed investing in the data center and local area network (campus) to grow. the ability to work remotely for their employees. But some of the constraints seem deeper because the Cisco portfolio doesn’t fully capture the opportunities that cloud computing represents for technology vendors.
As a result, management announced a new phase in the company’s transformation.
Transition to products as services
During the earnings call, Robbins announced, “We will accelerate the process of converting much of our portfolio to be distributed as a service.”
That represents a dramatic change for the company. Management does not disclose the percentage of sales currently distributed as a service, but can assume that this represents a portion of the representative 51% of 12-month gross sales (TTM). for software and services (the rest is for hardware).
And even if Chief Financial Officer Kelly Kramer says the company will propose multiple services as one by the end of 2020, this transition will last for a few years, as it will also involve portfolio sections. harden his extensive network.
Hence, you should take into account the performance risks associated with such a decision.
The company will rebalance spending on research and development, amounting to $ 6.3 billion over the past 12 months, to fuel this transformation. But it remains to be seen whether Cisco will succeed in these efforts against fast-growing cloud-specialist competitors such as video communications gurus. Zoom Media Video, costume supervision Datadogand network security player CrowdStrike.
Additionally, with $ 14.8 billion in cash, cash equivalents, and investments in excess of total debt at the end of the previous quarter, Cisco could conduct conversion acquisitions to speed the transition. . But it can pay too much for such transactions as many technology stocks have risen to their high valuations in the past few quarters.
Due to these uncertainties, Cisco shares appear to be reasonably priced with the TTM enterprise’s value to revenue (P / E) ratio of 3.6 and 17, respectively. , 0.
However, besides moving to solutions as a risky – but necessary – service, the company still faces long-term trends that new technologies represent – 5G, Wi-Fi 6. and 400G.
In addition, during the previous quarter, the company maintained its non-GAAP (adjusted) gross margin to 65%, compared to 65.5% a year ago, indicating that it has held a certain strength. its price. In addition, thanks to its large scale, the company’s operating margin remained high at 33%, up from 32.6% in the previous quarter. And management announced that the company will save $ 1 billion per year, which will support this high return in the transition.
However, given the company’s modest valuation, the market doesn’t account for any upside potential. Therefore, investors who want to get exposed to cloud computing at a reasonable price should consider buying Cisco shares.