A Dominant Tech Company

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

At one point in time Cisco (NASDAQ: CSCO) was larger than life.  During the dot com boom, for instance, Cisco’s stock price skyrocketed.  It seemed as though this company could grow forever.

Cisco’s valuation was then brought back to earth.  John Chambers, the CEO of Cisco, reportedly received death threats after the share price reflected a reasonable valuation of the company. 

Today this company is selling at around $20 per share, pays a dividend of around 3%, consistently grows earnings and revenues, and tends to under-promise and over-deliver.  That said, I feel that this stock is a stock that you could buy and hold – and not lose any sleep at night, particularly given Cisco’s conservative management philosophy.

Steady Eddy

Although some people have characterized Cisco’s CEO John Chambers as stingy because he was unwilling to return some of Cisco’s cash to its shareholders (even though he did eventually capitulate), I have nicknamed him Steady Eddy. 

Unlike many others, I think that Steady Eddy does a decent job.  After all, it is not his fault that shareholders had unrealistic expectations. 

Steady Eddy understands how the earnings game is played: under estimate and then over-deliver.  In fact, this company has beaten earnings estimates something like all of the last 8 quarters, which is a pretty big deal.  That is in sharp contrast to Cisco’s competitors such as Juniper Networks (NYSE: JNPR), whose performance is erratic.

You know what you are going to get with John Chambers: a modest level of growth, a conservative growth through acquisition strategy, and a publicly stated plan to become the world’s ‘#1 IT Company.’ 

Market Share Leadership

Cisco understands the importance of market share leadership – or having a controlling position in the market.  That is why Cisco has a target market share of at least 40% in all of its markets and doesn’t tend stay in a market unless it has a market share of at least 20%.  Having a dominant position in a market allows Cisco to maintain its margins and profitability.    

Cisco dominates the data networking industry – its share of the $21 billion switch market has remained at over 70% each of the past 5 years, while its closest rival, HP, has a mere 5%.  Cisco also dominates the router space, competing with a clearly inferior opponent, Juniper Networks. 

Cisco has acquired companies not only to enhance its competitive position in markets, but also to gain share leadership in new emerging markets. 

A Sensible M&A Strategy

Cisco has made it clear that it is focused on acquiring software-based assets that support Cisco’s integrated solutions model.  To that end, Cisco has made small acquisitions in the hundred to several hundred million dollar ranges, with the occasional billion or multi-billion dollar deal. 

In 2012, for instance, Cisco purchased Meraki for $1.2 billion, Cloupia for $125 million, and Cariden for $141 million.  Meraki, a company with a dominant footprint in cloud computing and mobile, will reportedly form the basis for Cisco’s Cloud Networking Group.  Cloupia, whose products automate converged data center operations, will augment Cisco’s Data Center Group. Cariden, a company focused on software-based network-planning, will roll up into Cisco’s Service Provider Networking Group.        

To date, John Chambers has executed a very conservative acquisition strategy.  Chambers has, however, indicated that he would consider acquisitions of up to $20 billion (about 50% of Cisco's cash on hand), a fairly large dollar amount, which has raised a lot of speculation.  Moving forward, most (if not all) of Cisco’s acquisitions will focus on high margin software and services and on ‘catching up’ in mobility. 

An Attractive Valuation

Given Cisco’s strategy of focusing on software, I feel that Juniper and International Business Machines (NYSE: IBM) are two logical companies to use as comparators.  Juniper Networks is currently Cisco’s major competitor in routers, whereas IBM is Cisco’s most logical major future competitor in the software and services space.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Cisco</p> </td> <td> <p>Juniper</p> </td> <td> <p>IBM</p> </td> </tr> <tr> <td> <p>Price to Earnings</p> </td> <td> <p>13.2</p> </td> <td> <p>58.8</p> </td> <td> <p>14.0</p> </td> </tr> <tr> <td> <p>Dividend Yield</p> </td> <td> <p>2.73%</p> </td> <td> <p>0%</p> </td> <td> <p>1.75%</p> </td> </tr> <tr> <td> <p>Gross Margin</p> </td> <td> <p>61.2%</p> </td> <td> <p>61.6%</p> </td> <td> <p>47.6%</p> </td> </tr> <tr> <td> <p>Sales Growth</p> </td> <td> <p>6.6%</p> </td> <td> <p>8.7%</p> </td> <td> <p>7.1%</p> </td> </tr> <tr> <td> <p>Earnings Growth</p> </td> <td> <p>23.9%</p> </td> <td> <p>- 31.3%</p> </td> <td> <p>6.9%</p> </td> </tr> <tr> <td> <p>Market Capitalization</p> </td> <td> <p>$109 Billion</p> </td> <td> <p>$11 Billion</p> </td> <td> <p>$220 Billion</p> </td> </tr> </tbody> </table>

Of these three companies, it appears as though Cisco has the most attractive valuation.  Compared to Juniper Networks, Cisco has managed to grow earnings while Juniper has seen earnings deteriorate.  For a variety of reasons, I do not feel that Juniper Networks can compete with Cisco over the long haul.

Cisco also compares favorably to IBM across the spectrum of valuation metrics.  Similar to IBM, Cisco also has a sales team that is known for executing very well and a compelling suite of products and solutions, which allows Cisco to maintain its margins and profitability.  In the future, over the medium to long term I feel that Cisco is well positioned to steal market share in the highly profitable software and services space. 

3 Reasons to Consider Purchasing Cisco

  1. Market Share Leadership:  Cisco ensures that it maintains a dominant position in all of its markets.  Cisco set forth a vision of being the ‘#1 IT Company’ and has the scale and product portfolio to achieve this goal.           
  2. A Compelling Suite of Products and Solutions:  Cisco has a phenomenal product portfolio that allows it to maintain its margins even in the toughest of times. 
  3. A Sensible Acquisition Strategy:  Cisco has very methodologically used acquisitions as a vehicle to build capability, as well as to enter new markets and obtain a dominant competitive position.             

 My Foolish Take

On one hand, every now and then you still hear the saber rattling or displeasure with John Chambers at CEO.  Or you hear about a product that flopped, or about another restructuring.     

But John Chambers has a solid track record for consistently beating the street and delivering top and bottom line growth.  Sure, he has made a few bad decisions here and there, but he has learned from them and Cisco is a better company because of those lessons. 

Cisco has a sustainable dividend, a very strong brand, a compelling product portfolio, a ton of cash on hand, a sensible growth through acquisition strategy, and a dominant position in several different markets.  That is why I feel that at an entry price point below $20 per share Cisco is very attractively valued.  At that price point, investors can reasonably expect a very solid total return of 10% – 15% per year over the next few years with minimal downside risk.  

RyanPeckyno is long Cisco. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines.. 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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