Behind Cisco's Happy Talk


By Sam Jaffe A rose is a rose is a rose. But there was something that didn't smell quite so sweet with Cisco's otherwise rosy fiscal first-quarter results. At first glance, its figures seemed like a triumph. Although Cisco (CSCO) recorded a slight loss, it did increase its revenues for the first three-month period since the beginning of 2001, and it bragged of increased market share and expanded gross profit margins. The market responded accordingly, raising the stock's price almost 6% since Nov. 5, when news of the results first started to leak out.

A closer look at Cisco's results, though, shows some weakness in the victory. The revenue gain was partially due to accounting adjustments. And the all-important router segment, Cisco's cereal crop, saw a decline from the previous quarter. Most important, Cisco executives provided little hard evidence that the company was gaining market share.

REGAINING LOST GROUND? That's important because CEO John Chambers has set market-share gains as the company's primary goal in this downturn. He has repeatedly said the strong get stronger when the economy heads south, and this should be Cisco's time to shine. But so far, it hasn't been able to add much to its luster. The more likely scenario is that Cisco is hurting just as much as everyone else.

"In all fairness they probably did gain a little bit of market share," says Robertson Stephens analyst Paul Johnson, who has a neutral rating on the stock. "But probably it's a case of gaining back the market share they lost last quarter."

You wouldn't be able to tell that from Chambers' comments during the Nov. 6 conference call announcing the quarterly results. He stressed the fact that Cisco's eight main competitors are all seeing an ongoing revenue decline in this quarter, while Cisco's revenue is growing. But Chambers didn't cite any private-sector market surveys, which the company has done in the past, to emphasize how well Cisco is doing in its markets.

UNCLE SAM'S ORDERS. The most likely reason Chambers didn't talk about those numbers is because they aren't heartening. Every survey by consultancies like IDC and Dell'Oro Group shows Cisco holding steady in most of its markets. That's worth highlighting. And it has stanched the losses in the router market that were the result of Juniper Networks' (JNPR) competitive challenge. Another bright spot.

However, Chambers insists on talking about market-share gains. And one look at router revenue shows that while Cisco is holding its own, it doesn't appear to be gaining ground. In its fiscal fourth quarter that ended July 31, routers accounted for 40% of overall sales. In the fiscal first quarter, they represented 36%.

Cisco's results contain another potential land mine. The federal government extended the close of its fiscal year by two weeks, to Oct. 15, due to the September 11 attacks. Because a lot of government technology purchasing happens at the end of every fiscal year, Cisco did enjoy a bump in sales in October, but that's unlikely to be repeated in 2002.

WHAT'S WORRISOME. Shouldn't investors just be happy that Cisco is keeping its head above water? After all, the company was still able to sell $4.4 billion worth of equipment in the third quarter, when the economy most likely slid into recession. And even if things get worse, it boasts a cash pile of more than $19 billion. That's enough to get it through years of losses like this quarter's.

The worrisome part comes when you look at Cisco's current stock price. At around $18 a share, its price-to-future earnings ratio is 44. That's more than double the forward p-e of the Standard & Poor's 500. And there's no promise of the news getting any better in the near term. Chambers, although decidedly upbeat in the conference call, admitted that he couldn't estimate future orders beyond a few months.

Fair enough. What Chambers said was, despite what he called a "linearity" in orders, "there's still not much visibility." If things are linear, then visibility should be apparent, too. And when visibility vanishes, it often means hard rain ahead. Jaffe writes about the markets for BusinessWeek Online in our daily Street Wise column


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