The Internet equipment market isn’t going anywhere. Stocks hed: Is it time to buy Cisco? dek: The Internet equipment market isn’t going anywhere.
What a difference a year makes; we’ve heard the cliché a thousand times. Last year at this time, Cisco was the toast of a booming tech sector. It boasted more than 60 acquisitions since 1993, a $555 billion market cap, and everyone’s consensus CEO of the year was John Chambers. But recent news has the company laying off 8,500 workers on the heels of a 3,000-worker layoff and two consecutive quarters of disappointing earnings results. The stock is down in the low 20s as of this writing, from a high of more than $80 per share, and its market cap is down to merely $100 billion or so.
It would be simplistic to say that the downturn is the only cause here, because some tech companies of similar size have weathered the downturn fairly well–namely IBM and Microsoft. To me, the root of the problem is in the way the company is managed. Specifically, it is managed as a growth-trumps-all company, and that model has proven flimsy as many New Economy rules are exposed as naive.
And Cisco has not grown in the traditional way–through research and development and finding new markets for its core products. It has primarily grown through acquisition. Growth through acquisition works great when the economy is going well, but companies need much more than that to weather downturns.
First and foremost, companies need solid, unified management structures that assimilate the different corporate cultures strung together through acquisition. Take IBM. In the early ’90s, it was a company in which the inmates were running the asylum. All these divisions sold against one another, stole secrets from one another, and generally acted like a bunch of fiefdoms with no central master.
Enter Lou Gertsner, who unified all products into one consistent pitch (in some cases jettisoning those that did not fit the new world order) and simplified the sales and service processes. It took time, but IBM became a diversified company with one message: “We have a solution for every company; it’s just a matter of fitting one or more of our products to the clients’ needs.”
Cisco has acquired too many companies too fast to get them all to work as one entity. It usually take a year or more for an acquired company to fit the mold. And when Cisco is acquiring dozens of companies a year, it can never act as one unit. To weather the downturn, Chambers needs to declare a 12-month moratorium on acquisitions. Fortunately, enough of his advisors agree, as the company has not acquired anyone in recent months. Without a clear R&D focus, acquisitions don’t always make sense. A company needs to have an R&D direction in order to adequately assess whether an acquisition is a good fit or if it’s too far afield.
So will its heavy reliance on acquisitions and insufficient R&D focus hinder its chances to come back as the market comes back? Somewhat. But not to the degree that its stock price as of this writing suggests. The market for switches and routers will continue to strengthen with the economy and Cisco will continue to grow its earnings faster than the rebound. Despite its management challenges, Cisco is a bargain. I would buy cautiously, however. The average analyst target price is $28 a share or so, which could be eclipsed by the time this goes to press. If the stock stays in the low to mid 20s, I will buy my mythical thousand shares for the CU fund and hang on to it for the long haul.