Is Cisco Putting Its Money To Good Use?

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

Any time I come across a company with lots of cash but below average growth, I begin to play matchmaker. I’ll take that company and put in “column A” and I’ll try to pair it up with companies in “column B” that I think can bring in growth – except it doesn’t always work. Hewlett-Packard’s botched deal for Autonomy serves as a prime example.

Is Cisco’s Recent Spending out of Control?

That’s the question investors have been asking. In light of HP’s embarrassing deal, it’s hard to not get nervous with Cisco’s (NASDAQ: CSCO) recent shopping spree. Not only has the network giant announced three deals last month, but this has brought Cisco’s cloud-based acquisition total to nine this year. These include paying $141 million in cash for Cariden and another $1.2 billion for Meraki – both within the past two weeks.

It seems like too much money. But on the other hand, the market won’t truly know the value of these deals until Cisco releases earnings results. It's only at that point investors will see the impact of these acquired companies. In the meantime, Cisco deserves the benefit of the doubt to prove that it can realize the value that the cost of these deals presume. What’s more, the company’s recent earnings announcement offered a glimpse into what Cisco is thinking.

Cisco got its fiscal 2013 started on the right foot by reporting net income of $2.6 billion, or $0.48 per share on revenues of $11.9 billion. Remarkably, not only did this represent 6% revenue growth, but Cisco’s profits surged 11%, which helped the company amass $45 billion in cash. Cisco realized that its cash was growing, but revenues stayed at mid-single digits.

Cisco also noticed that its service business is growing at an impressive rate – 12% year-over-year. But on the other hand, the company’s core routing and switching business continues to be weak. This has been a recurring theme and explains precisely why the company has been investing in businesses that combine cloud-based services and offer enterprise LAN management.

In other words, Cisco has been investing in its future. This is where it anticipates larger growth opportunities. What’s more, Cisco understands that its current lead in routing and switching won’t mean anything once customers start migrating out of hardware and into software-based network solutions. And evidence suggests that is exactly what is beginning to happen. This explains where the majority of its cash has been going.

Additionaly, with the cloud market expected to grow to $177 billion over the next three years, it would be foolish for Cisco not to execute in that direction. In other words, Cisco’s future depends on these deals. I can’t fault the company for looking at any opportunity that might present any type of competitive advantage.

For Cisco, growth has not come in sufficient quantities – at least not according to Wall Street. So I think investors should be encouraged that the company is opening up its wallet to do something about that. In that regard, I seriously doubt that Cisco’s shopping spree is over – at least I hope it isn’t.

Managing the Competition

As the cloud market fully takes shape, there are other areas where I think Cisco can separate itself from the rest of the pack, which includes rivals such as F5, Juniper (NYSE: JNPR) and Riverbed. The company should consider acquiring Palo Alto Networks (NYSE: PANW). Palo Alto is young but growing at an incredible rate, including revenue jumping 90% year-over-year and 15% sequentially.

However, it’s more than just a growth story, Palo Alto has incredible technology. The company has pioneered what is considered next generation security along with a platform that is considered one of the most innovative in the industry. A Palo Alto acquisition would present Cisco with a portfolio of services that is unmatched by any rival and help the company give Fortinet (NASDAQ: FTNT) and Dell (NASDAQ: DELL) reasons to drool.

Security services has become a huge market. Plus with "the cloud" not yet fully understood, companies are feeling uncomfortable about sending their "big data" into cybersapce. For this reason, Fortinet has made considerable investment in this area as evident by its R&D expenses, which has grown to almost $4 million. Although Fortinet's margins took a hit, the company still managed to report profits that arrived in-line with estimates. 

Likewise, Dell's acquisition of enterprise security giant SonicWall, for which it paid $1.2 billion, speaks to the urgency with which these M&A deals are beginning to move. Dell understands that its PC business is no longer going to bring in the goods. So as a way to strike first, it felt SonicWall was a deal it couldn't pass up. Whether or not it was the right move remains to be seen. But it is hard to argue the justification.

Likewise, this is what Cisco is thinking. It's recent acquisitions (if nothing else) are keeping these smaller names out of the hands of rivals. Cisco knows that these deals will pay off at some point. But in the process, Cisco is playing defense against the likes of Hewlett-Packard and Juniper.

I'm surprised that Juniper has remained silent throughout all of these deals. At one point it was considered Cisco's main rival - except Juniper has failed to sustain any type of growth momentum. Now the company is trying to prove that there is value in its shares. Unfortunately, it has not proven this in its recent earnings results, which followed poor guidance. 

Bottom line

In Cisco’s case, the company is making all the right moves. As to whether or not Cisco is overspending, well, it’s too early to say. As much as I think companies should be forever cautious when making deals, fear of failure is not enough to avoid them either – especially if they offer something that the acquiring company can’t do without.

Cisco wants to return value to shareholders. In doing so, the company’s challenge is figuring out ways to grow while fighting off the competition. These reasons alone serve as justification for the company’s recent spending. We can issue our report cards later.

rsaintvilus has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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