Cisco’s Worth $23 On Cloud Foray And Enterprise Strength

Cisco (NASDAQ:CSCO) recently debuted its virtual cloud-routing and WAN optimization platform under the Cisco Cloud Connected Solution brand. The new product solution will help businesses take advantage of cloud computing to deploy cloud-related services and transition their virtual private networks into the cloud. It would also address the traditional cloud computing concerns of speed and bandwidth problems to “offer an optimal user experience at the lowest cost”. ^[1] With businesses increasingly looking to move their applications to the cloud, Cisco’s move will help it address the changing trends and drive its earnings higher in the future.

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Cisco’s enterprise muscle

Enterprise routing is a Cisco stronghold with the company boasting of as many as 500,000 customers who have deployed its routing solutions worldwide. It has more than 77% market share of the global enterprise router market, as per our estimates.

The introduction of the Cloud Connecters software in the integrated cloud solution should therefore help Cisco leverage its enterprise lead to become a leading software company. The fact that Cisco is actively focusing on the cloud is also a good sign for the future and shows that its restructuring and turnaround efforts have realigned the company’s focus on key growth areas in its services business. With data demand exploding and restructuring initiatives taking hold, we believe that Cisco is well positioned to grow revenues at a healthy rate in the future.

As a result of the restructuring initiatives, the company has been able to keep its expenses low and make operations more efficient. This will help it meet its guidance of being able to grow earnings at a faster rate than revenues. The recent quarterly results showed that the company’s operating margins which were fluctuating widely as a result of the restructuring were stabilizing, as Cisco reported its second consecutive quarter of solid operating margin of around 24% after fluctuating between a low of 13% and a high of 24% in the recent past. With $945 million of the total $1 billion of severance charges related to the workforce reduction program announced in July 2011 already realized, we believe that the operating margins will remain fairly stable from hereon.

Deeply undervalued at market price

However, Cisco has warned that technology spending could take a hit in the coming months due to the macro-economic uncertainty surrounding the European debt crisis. Still, longer-term, Cisco’s outlook looks strong not only due to an industry-wide change of fortunes once the uncertainty eases but also the company’s bigger market share within the industry. The company’s strong market position has helped it outperform rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far, and will help it even further when the concerns subside.

With the company getting refocused on its core businesses and driving efficiency in its operations, we believe that it is being deeply undervalued at its current market price. We maintain our price estimate of $23.40 for Cisco, suggesting a 40% upside to the current market price as our model takes into account the aforementioned concerns together with the company’s long-term plan of achieving stable operating margins in the mid-20s.

Cisco also has tons of cash – more than a third of its current market capitalization. It has also been generating huge positive cash flows in the order of billions from operations every quarter despite a challenging economic environment.

We believe that the company will continue to execute well on its turnaround plans, banking on a leaner structure to grow its profits at a rate higher than revenues. A positive cash flow will ensure that the company is able to return cash to shareholders through regular dividends and share repurchases.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Cisco Accelerates Businesses’ Transition to the Cloud with Innovative Cloud Connected Solution, Cisco Press Release, June 12th, 2012 [↩]