• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Bruce Kamich
    • Doug Kass
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / U.S. Equity

Cisco's New Long-Term Targets Show How Challenging Its Transition Is

The networking giant is forecasting limited sales and earnings growth for the next few years, as hardware pressures offset software and services growth.
By ERIC JHONSA
Jun 30, 2017 | 10:39 PM EDT
Stocks quotes in this article: CSCO, HPE, ANET, JNPR, NOK, IBM

If there's a silver lining to the reduced long-term revenue and EPS growth targets that Cisco Systems Inc. (CSCO) just provided, it's that markets weren't bothered by the numbers. Cisco closed up 1.4% on June 28, the day the outlook was given, slightly beating the Nasdaq's 1% gain.

That, of course, has much to do with how cheap Cisco shares are: With the networking giant trading for less than 13 times its fiscal 2018 (ends in July 2018) consensus EPS estimate even after a giant Nasdaq rally, markets aren't counting on anything more than modest earnings growth in the coming years.

But for those hoping that Cisco's aggressive moves to grow its software and services exposure will pave the way for the company to return to double-digit earnings growth, its targets have to be considered disappointing, a harsh reminder of just how much of a headwind Cisco's exposure to hardware franchises facing major long-term pressures stands to be even as its software and subscription revenue swells.

At its 2017 analyst day, held at the annual Cisco Live partner conference, Cisco forecast it would see just 1% to 3% annual revenue growth, and "mid-single digit" annual EPS growth over the next three to five years. The outlook was provided during CFO Kelly Kramer's portion of Cisco's analyst day presentation, and can be found in Kramer's presentation slides.

The growth targets are below the ones Cisco issued in late 2013, when it forecast 3% to 6% revenue growth, and 5% to 7% EPS growth, for the following three to five years. Assuming Cisco hits a fiscal 2017 EPS consensus of $2.38, the company's compound annual EPS growth since fiscal 2013 will have been around 4%, slightly missing its target range.

Also: In spite of its software/services shift, Cisco is only forecasting its margin growth will be flat to positive. On the bright side, the company does promise to keep returning over half of its free cash flow (FCF) to shareholders.

 

The long-term targets provided at Cisco's analyst day.

The biggest culprit behind Cisco's subdued outlook: The company only expects its "infrastructure platforms" business -- it covers switching, routing, Wi-Fi and server products, and currently gets just 14% of its sales from software -- to see roughly flat revenue growth. In addition, Cisco's "Other" businesses, which include things like conferencing and cable/telco video hardware, are expected to decline at a mid-single digit clip.

That's largely expected to offset stronger growth in other areas that Cisco has prioritized. Sales of application software, including subscription-based cloud apps, are expected to grow at a high-single digit to low-teens clip. Security product sales, nearly half of which are now software-related, are expected to see low-to-mid teens growth. And services revenue is expected to grow at a mid-single digit rate.

Cisco's main problem: Its "infrastructure platform" and "other" offerings account for over two-thirds of its current product sales, which in turn account for 74% of its total revenue. Moreover, much of the 26% of revenue that comes from services still involved support and maintenance contracts for the aforementioned products.

Cisco does expect its deferred revenue balance, which totaled $17.3 billion at the end of its April quarter, to post a 5% to 10% compound annual growth rate (CAGR) over the next three years, thanks to an expected 20% CAGR for product deferred revenue related to software and subscriptions (currently at $4.4 billion). If not for the push-out of some sales into the deferred revenue balance, Cisco's revenue growth target would look slightly stronger.

But given the impact of this push-out in recent quarters, we might be looking at just a 2% revenue growth difference in the short-term, and -- as various software businesses largely transition towards subscriptions -- possibly less in the long-term. It's also worth keeping in mind that delivering 1% to 3% sales growth would be a clear improvement over near-term sales trends: Cisco's revenue fell 1% annually in the April quarter, and has been guided to drop 4% to 6% in the July quarter.

A run-down of the major secular challenges faced by Cisco's hardware operations provide context to the company's sales outlook. A few of the big ones:

  • The adoption of third-party software-defined networking (SDN) platforms will let companies more easily deploy commodity switches within data center networks, and the adoption of network functions virtualization (NFV) will let carriers replace some telecom equipment with software running on commodity servers.
  • Cloud giants such as Amazon, Google and Facebook are relying heavily on switches they either designed themselves, or open-source switch designs from initiatives such as the Facebook-led Open Compute Project (OCP). And as Cisco clients move more workloads to cloud infrastructures featuring these switches, they don't need to spend as much on switches for their own data centers.
  • Telecom capital spending remains pressured, as wireline and mobile carriers seeing little or no revenue growth try to restrain their spending.
  • Switching rivals such as HP Enterprise Inc. (HPE) , Huawei and Arista Networks Inc. (ANET) have been collectively taking share. Likewise, Juniper Networks Inc. (JNPR) and Nokia Oyj (NOK) have been providing tough competition in the carrier router market.

Amid all of these challenges, Cisco has been doing some pretty smart things. Launching networking software solutions such as the ACI SDN platform, its Tetration data center analytics software and (most recently) its DNA platform for automating office network functions that IT admins have to do manually serve to better differentiate the company's hardware platforms amid growing threats. They also grow the amount of long-term revenue Cisco can produce from those hardware clients that stay loyal, extra spending that clients can justify due to benefits such as lower IT operations costs and better security.


An example of how Cisco expects software subscriptions to grow the revenue opportunity for a switching product line.

Cisco is also wisely using M&A to expand into adjacent software and services markets that complement its existing product line: Examples include its $3.7 billion purchase of leading app performance monitoring (APM) software firm AppDynamics and its $1.4 billion-plus purchase of leading IoT connectivity management service provider Jasper Technologies. And its efforts -- both via M&A and organic investments -- to grow its exposure to a security market that remains a strong point for IT spending -- have generally paid off.

The net result of all these moves, however, may simply be to allow Cisco to deliver modest organic growth in the coming years. That might admittedly prove a better outcome than what some IT peers, such as HPE and IBM Corp. (IBM) , could be facing given their own secular pressures. But those expecting something better still might end up disappointed.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

Jim Cramer and the AAP team hold a position in Cisco for their Action Alerts PLUS Charitable Trust Portfolio .

TAGS: Investing | U.S. Equity

More from U.S. Equity

Food for Thought on 2 Restaurant Stocks

Paul Price
Jul 5, 2022 7:00 AM EDT

Being approximately correct in your timing decisions is all you need to make a ton of money.

Tuesday Setup, Semiconductor Gut Punch, Tradable July? Stay Inside the Lines

Stephen Guilfoyle
Jul 5, 2022 6:43 AM EDT

Earnings season kicks off in about 10 days. It does not look to the plain eye that analysts are ready.

A REIT With Large Total Return Potential and a Generous Current Yield

Paul Price
Jul 4, 2022 9:00 AM EDT

The safe route is to buy shares, collect the generous dividends and reap the rewards when valuations revert back to normal.

As Carnival, Royal Caribbean and Norwegian Sink, Here's When to Dive In

Ed Ponsi
Jun 30, 2022 1:30 PM EDT

These stocks are priced for an industry-wide calamity, but how realistic is that considering their customer base?

Market Trends in Question as Support Levels Breached

Guy Ortmann
Jun 30, 2022 10:02 AM EDT

The near-term is getting tougher to call as each rally has been short-lived.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 07:34 AM EDT PAUL PRICE

    A $525,000 Vote of Confidence on Macerich (MAC)

  • 09:49 AM EDT JAMES "REV SHARK" DEPORRE

    This Weekend on Real Money

    Stop Wishing, Hoping, and Praying and Take Control...
  • 07:59 PM EDT PAUL PRICE

    Very Good Quarterly Numbers From Bassett Furniture (BSET)

    Bassett Furniture blew right through analysts es...
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2022 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login