The Quiet Tech Titan You Can't Afford To Ignore

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

Cisco Systems (NASDAQ: CSCO) has seen its stock increase almost $5 per share since November, and it's now trading at over $21 a share.  The company is on track to continue seeing such increases throughout 2013.  While investors have focused heavily on the consumer end of technology stocks, Cisco has quietly begun to reassert itself in the enterprise and software markets.

Strategic acquisitions

While Cisco has long dominated the routing and switching market, it has not been able to sustain much growth in the area. The company is hoping to change that going into the future. It's making a few solid, smart acquisitions, most notably Cariden, a network management software company and Meraki. These purchases will help the company continue to invest in a cloud computing presence. The Cariden acquisition will help Cisco service mobile providers in managing online traffic software, allowing Cisco to capitalize on the growing mobile market. The Meraki acquisition will greatly expand Cisco’s presence in the cloud computing sphere, particularly in the mid-size and small market sector – the fastest-growing sector in the market.

These acquisitions of small but solid technology companies represent a trend in the business technology sector. Juniper Networks purchased Contrail Systems for $176 million last month. Contrail’s business lies in the development of software to update and configure networking equipment, which makes it easier and cheaper for customers than manually configuring the hardware.  This gives Juniper an immediate source of software technology to sell to customers.

IBM (NYSE: IBM) offers a very clear example of how acquisitions can propel a company, particularly when those acquisitions focus on expanding software business.  In November 2008, IBM was trading at less than $75 per share. The company then announced a series of large acquisitions over the next few years, beginning with SPSS, Inc. in 2009, a company that provides software for statistical analysis. Cast Iron Systems, a cloud integration company, was purchased by IBM in 2010 along with Sterling Commerce, a company that provided business software integration. Later in 2010, IBM purchased the data warehousing and analytics company Netezza.  The company continued to buy other software-based businesses such as these and the stock now trades at over $200 per share, a testament to how acquisitions can quickly result in huge gains.

Cloud computing is the future

Cisco will complete its acquisition of Cariden in the second quarter of 2013.  Cariden is a company that produces optical software for ISP networks.  With Cariden Cisco will now have many large ISP’s purchasing its software.  This is big news in the cloud computing and date center world as Cariden’s software defined networking allows customers to separate network hardware from applications running on it.  In addition, Cisco will now be able to help ISP customers optimize their bandwidth routing through software Cariden has produced that allows the ISPs to send information on the most optimal routes across their networks.  This will speed up networks as well as lower costs.

While long a leader in traditional data center solutions, the acquisition of Cariden will go a long way towards making Cisco a major player in the cloud data center market.  The latter is the future of the market and Cisco is poised to be a leader in 2013.

Cariden makes software that it sells to many large service providers that virtualize their networks.  This allows Cisco’s service provider customers to receive the benefits of software defined networking which is becoming popular in the cloud computing world as a way to abstract network hardware from hardware running on top of it. With this acquisition Cisco is better positioned to capitalize on the strong growth of the cloud data center market in the coming years.

Cisco will push these concepts as part of its Cisco Unified Access umbrella. This is a strategy to unify customers’ wired, wireless, and private networks into a single structure. Such a move continues Cisco’s lead role as a network solutions company and also makes it a major player in the cloud computing market.

Software emphasis

Once this deal is completed it will also serve as a warning call to Cisco competitor salesforce.com (NYSE: CRM), a growing player on the software side of the cloud computing market. Salesforce.com has seen phenomenal growth, trading at just above $22 per share at the end of 2008 to sitting at over $171 today.  This is a result of the demand for the software products associated with cloud computing. 

Salesforce.com did very well in predicting the move to cloud computing and mobile devices as it shifted its software focus in those areas just ahead of the curve.  While Cisco might be playing catch-up with salesforce.com in the software market, Cisco is making a profit while saleforce.com is not.

Cisco has clearly been oriented as a hardware company first, but the Cariden acquisition is a strong sign that it is not going to relinquish the software business without a fight.  Another hardware company that refocused on software is IBM, which has seen tremendous success with its move towards software emphasis. IBM has been able to create a synergy that software only companies (like salesforce.com) cannot compete.

Capturing part the cloud computing market and data analytics market has created profits for IBM, even as revenue remained flat, given the higher margins in software sales. Besides the solid growth in stock price talked about earlier, IBM has seen a solid trend line in earnings growth over the past years as it turned more attention to software.   

Oracle has been able to grow its business, despite sluggish hardware sales, by relying on its software business.  It has seen its stock price grow by more than 150% in the last four years, while seeing steady earnings growth. Cisco appears to be following the IBM model, which will result in strong growth for the company in 2013. The higher margins from software sales more than offset the slowdown in the hardware market.

Conclusion

2013 will see Cisco emphasize its core service provider business. Offering ISPs software to consolidate different network assets under a single roof that will allow its customers to more easily manage and control their assets. While this is not a sexy, bold move, it is evidence that Cisco is serious about serving its business customers and simplifying their networks. This is a solid move that will result in Cisco seeing better-than-25% growth in 2013.


StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems and Salesforce.com. 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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