Will Cisco’s Focus on a New Internet Unlock Value?

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Cisco (NASDAQ: CSCO) recently announced that the company plans to double its revenue from software, which is currently at $6 billion. CEO John Chambers said the growth will be mostly organic but will include some acquisitions. Cisco’s original business of routers and switches currently generates almost half of its total revenue.

Cisco has already entered in the areas of cloud computing, data centers, and applications. The company is aiming for eventually transforming itself into an all-round IT player in the "Internet of Things."

What is the Internet of Things

The Internet of Things is a vision being built today. It’s the idea that at some point billions of electronic devices and sensors will be connected to the Internet in parallel to the hundreds of millions of people who have access to the web. The idea of the Internet of Things is on the verge of becoming a reality due to the following three factors:

  1. A big factor is the plunging cost of connectivity, which is being driven by the emergence of Heterogeneous Networks (often referred to as “HetNets”). HetNets offer a way to increase the density and bandwidth available to mobile devices. While the rise of HetNets is driven by insatiable consumer demand for smartphone bandwidth, the biggest impact will be felt when it becomes cost-effective to connect just about anything (cars, washing machines, vending machines, lights, etc.) to the Internet.
  2. The second major factor driving the Internet of Things is the explosion of low-cost, smart, standardized sensor networks.
  3. Finally, all these devices and services are increasingly being stitched together with online services for better integration.

Cisco’s Cloud Based New Initiatives

Cisco is banking on its expertise in networking to emerge as an integrated player in the Internet of Things. The company recently launched its virtual cloud-routing and HetNets platform under the Cisco Cloud Connected Solution brand. The new product solution will help businesses take advantage of cloud computing to deploy cloud-related services and transition their virtual private networks into the cloud. It would also address the traditional cloud computing concerns of speed and bandwidth problems to offer an optimal user experience at the lowest cost. 

Cisco’s CFO Frank Calderoni reiterated the company's target of 5%-7% compounded annual revenue growth in three to five years. Cisco's cloud and unified data center business is expected to post 20%-26% compounded annual growth in that time frame. In mobility the compounded annual growth rate will be 14%-17%. "Our wireless growth has been significant," Calderoni said, adding that Cisco had benefited from the growing demand for Wi-Fi and small cells that help offload traffic from networks. In network security, Cisco is expected to grow at a rate of 5%-7% in three to five years. The company is aiming for 6%-9% compounded annual growth rate in its video business.

With data demand exploding and businesses increasingly looking to move their applications to the cloud, Cisco is well positioned for addressing the changing trends and driving its revenues and earnings higher in the forthcoming quarters.

Cisco vs. Rivals

Enterprise routing is a Cisco stronghold, with the company boasting of as many as 500,000 customers who have deployed its routing solutions worldwide. Cisco’s strong market position has helped it outperform rivals Juniper (NYSE: JNPR) and Alcatel-Lucent (NYSE: ALU) in an uncertain economic environment for most of 2012. Analysts expect Cisco to deliver a yearly EPS of $1.92 in FY 2013. The stock is currently trading at an approximate forward PE multiple of just 10, which looks reasonably cheap. 

<img src="http://media.ycharts.com/charts/11860846221836f1e77a35c737d9faf5.png" />

CSCO EPS Diluted TTM data by YCharts

Cisco has lots of cash. As of the end of October, 2012 the company has $29 billion in cash net to debt on its balance sheet. With a strong cash position it makes a lot of sense for Cisco to increase its presence in high-margin areas like software and services. That would make Cisco more of an all-round IT company, much like International Business Machines (NYSE: IBM).

Cisco’s Free Cash Flow Yield currently stands at 10.08%, which is even better than IBM’s 7.57%. Free cash flow yield is usually meant to measure GAAP earnings per share divided by share price. Generally, the lower the ratio, the less attractive the investment is, and vice versa. The logic behind this is that investors would like to pay as small a price as possible for as many earnings as possible.

<img src="http://media.ycharts.com/charts/fed872c1fd3b7541f44a0ebdf0ffce1e.png" />

CSCO Free Cash Flow Yield data by YCharts

The Bottom Line

Cisco has been generating decent cash flows every quarter despite a challenging economic environment. A positive cash flow will ensure that the company is able to return cash to shareholders through regular dividends and share repurchases. For long term investors I would recommend buying the stock at the current price level. 

Anindya7 has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems, Inc.. The Motley Fool owns shares of International Business Machines Corp.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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