Are These Cloud Players Attractive at Current Prices?

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

Cloud computing is a hot topic in the tech sector today. For many tech firms like IBM (IBM) or Hewlett-Packard (HPQ), cloud computing solutions for business are assumed to be the business of the future. If your current business needs retooling, just acquire some cloud computing business units and ride off into the sunset. What could be simpler?

Poppycock. Cloud computing is not magic—not for corporate finance professionals and not for buy-side investors. (I sympathize: the remote and wireless aspects of a network seem like magic, but they are not magic.) Investors should be disciplined and refuse to pay outlandish valuations for hot tech trends. Regardless of technology, any stock needs to generate earnings and positive cash flows to be a viable investment. Business is business, and not all big tech companies can win by betting on the same trends.

Another Cloud Computing Acquisition

Cisco (NASDAQ: CSCO) declared that it will acquire Cariden Technologies for $141 million in cash and retention based incentives. Cariden, a privately held company, provides network planning to telecommunication companies along with providing design software and traffic management software. Cisco plans to complete the acquisition process in its fiscal quarter ending January 31.

Cisco has a strong reputation in the industry and is well known for growing by acquisition. The company has a strong client network and this acquisition will help in strengthening the relationship with the clients by making Cisco a one-stop provider of more cutting-edge networking services. Furthermore, this acquisition will also add up to the shareholders value in the long run. Just to recall, recently Cisco announced its interest in acquiring Meraki for $1.2 billion and Cloupia $125 million. Meraki is involved in the development of the computing-based hardware systems, whereas Cloupia develops data center management software.  

According to Surya Panditi, senior vice president and general manager of Cisco's service provider networking group, "The Cariden acquisition reinforces Cisco's commitment to offering service providers the technologies they need to optimize and monetize their networks and ultimately grow their businesses."

Checking Valuations

There are many different large cap firms which connect different devices or provide data storage solutions. They are valued from cheap to dear:

Ticker

Company

P/E

P/S

P/B

P/FCF

BRCD

Brocade

13.85

1.16

1.16

5.03

CSCO

Cisco Systems

12.2

2.15

1.91

11.71

EMC

EMC

20.34

2.46

2.41

9.67

JNPR

Juniper Networks

51.37

2.13

1.31

28.03

PANW

Palo Alto Networks

5442

14.48

16.15

58.85

RVBD

Riverbed

42.62

3.43

3.7

12.31

As it turns out, other valuations on this list are not sensible when considering disappointing sales and earnings developments.

EMC Disappoints

EMC (NYSE: EMC) slashed its revenue forecast after it revealed that quarterly earnings fell short of predictions. New, lowered guidance and its weak results were blamed mainly on a weak economy. EMC is the world’s largest maker of storage computers and had to deal with reduced demand as corporate clients curbed their spending to cope with the weak economy.

EMC’s Chief Executive Officer Joe Tucci ascertained that companies in the computer industry can only expect moderate sales growth. According to Tucci, “Economic and political uncertainties are affecting business confidence and this is affecting IT spending.”

Though EMC’s recent performance was below par, its majority stake in VMware is doing well. This company reported profits exceeding estimates in the third quarter which has been attributed to its gaining corporate clientele. VMware is the leading developer of software which enables computers to run multiple operating systems.

Juniper Profits Falling

Juniper Networks (NYSE: JNPR) reported profits that were below analyst estimates for the third quarter. This disappointment was attributed to increasing competition in computer network equipment from Cisco Systems. Caris & Co. analyst John Slack said, “The environment, particularly on the carrier side, is very difficult.”

Sweeping changes have been proposed for Juniper including a lay-off of 500 jobs and the adoption of new technologies. These technology investments are not likely to benefit the company until 2013. Though it will be upgrading its systems, its capital spending probably won’t meet historical levels in the current atmosphere of belt-tightening.

CISCO Lost Bid

Cisco lost a big contract when it submitted a bid to the California State University system that was roughly about six times more than the winning bid. The contract was won by Alcatel–Lucent (ALU) with a $22 million winning bid.

Cisco customers sometimes gripe that Cisco overprices its products. Cisco, denies this. Kim Maerus, Vice president for Cisco's education sales, said, “Put simply, there is no way that Cisco's bid was six times higher than the winning bid.” These figures are believed to have come from the person in charge of collecting the bids, Michael Davidorf, director at cyber infrastructure at CSU. Davidorf said, “All the vendors had to propose exactly the same solution.” The other companies were also given the same infrastructure list containing the requirements of CSU. Cisco provided the price list and available discounts for the given equipment.

It is speculated that Cisco came in higher for this project because Cisco already had struck a contract with San Jose State University for $28 million. Oddly, SJSU did not solicit bids for the project but simply tapped Cisco, possibly based on a common perception that Cisco is networking. If this was the case it could have put Cisco in a weird situation: it couldn’t bid lower than this amount because it would raise questions about their earlier contract. The company needed to be consistent with the earlier bid, or so goes the speculation.

These issues underscore the reality that Cisco will be forced to compete on price in the future. It is no longer the only game in town and now faces many competing companies.

Conclusion

It seems like many tech firms are rushing into cloud computing. Networking stocks are rapidly following data storage device makers and computer chip makers to fierce price competition, lower growth, and lower valuations. Cloud or not, profitability is not easy or guaranteed in any way. Instead, investors should recognize that each company is one of many rivals competing to service cash-strapped businesses with limited IT budgets.

Cisco and Brocade (BRCD) are among the cheapest stocks in cloud computing. Considering all price multiples, Brocade is cheaper than Cisco and is a better pick because it is less of a jumble of acquisitions. Investors should consider them as potential buys in this sector. EMC is too pricey based on valuation, and Juniper is richer still.


BillEdson11 has no positions in the stocks mentioned above. The Motley Fool owns shares of EMC. 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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