A Little Less Swagger at Cisco


By Peter Burrows In recent years, Cisco Systems (CSCO) CEO John Chambers seemed to welcome questions from Wall Street analysts about the competition. With Cisco dominating its computer-networking-equipment market and making absurdly high profits, he often praised the power of competition, essentially thanking rivals for keeping Cisco on its toes.

But Chamber's tone was different in the company's quarterly earnings call after the stock market closed on Nov. 9. While Cisco posted numbers rivals would kill for, the San Jose (Calif.) company's gross margin was 67.2%, down 1.5 percentage points vs. the year-ago figure. Stable margins in Cisco's service and support businesses helped offset an even deeper dip in product gross margins.

INVESTORS BLANCHED. One main reason for the drop: The competitors Chambers once magnanimously praised are suddenly putting pricing pressure on computer networking's king of the hill. "They acknowledged some additional competition, and that's something they haven't done for a while," says Lehman Brothers analyst Tim Luke. "The tone was generally more subdued."

Investors were clearly a little spooked. Besides the gross-margin pressure, sales in the quarter ending in January, 2005, are expected to grow only 2%, vs. the quarter just ended, which is slightly below consensus estimates. That drove Cisco shares down 2.53%, to $19.25 in after-hours trading on Nov. 9.

And those competitors? You wouldn't know from what Chambers had to say. Despite being asked directly, he refused to cite a particular company, opting instead to talk about unnamed Asian rivals. "We are starting to see a stream of good, and very price-competitive, competitors, particular from Asia. And we expect this to continue for the next decade," he said in the call.

UNFRIENDLY RIVALS. If Chambers isn't naming names, everyone on the call knew who he meant: Huawei Technologies. The fast-growing supplier is expanding in emerging markets such as its China homeland, India, and Brazil. Sources say Huawei is likely to land large chunks of a several huge impending contracts with China Telecom -- business that Cisco dominated in the past.

One can only imagine that Chambers wouldn't relish praising Huawei publicly. In July, Cisco settled a sweeping lawsuit with Huawei alleging many intellectual-property violations, including theft and use of Cisco source code. Cisco execs have said it was the first intellectual-property suit the company had brought against a rival.

Domestic rivals also went unmentioned. Tops on that list would be Cisco's Silicon Valley neighbor, Juniper Networks (JNPR). Its sales of networking equipment known as routers increased 19% in its most recent quarter, while Cisco's router sales slipped 11%. If Cisco's trouble in this market continues, it will hurt the outfit's pride as well as its financial performance.

"A LOT OF LUMPINESS." The slip is particularly wounding for Cisco veterans. After all, routers were invented by Cisco, which has always dominated the market. "Juniper has been taking share for a while, but this is more pronounced," says Erik Suppiger, an analyst at Pacific Growth Equities. "If you listen to the call, you'll see that they were pretty good about not mentioning Juniper at all."

Asked by Wall Street analysts about troubles in the router business, Chambers admitted that Cisco is "seeing a lot of lumpiness." But he also expressed confidence that the company's products would sustain Cisco's lead well into the future. "We're trying to not only create a company that's built to last, but that's built to lead," he said.

Certainly, Cisco still put up impresive numbers. Net sales hit $6 billion, up 17% from the same quarter a year go, while net income grew 28.5%. It added $1.5 billion in cash, helping maintain its massive cash horde at $17.7 billion -- despite buying back $3 billion in shares during the quarter.

CHANGING YARDSTICK. While Cisco has so far refused to pay a dividend, its board agreed to buy back an additional $10 billion in stock, on top of the $25 billion already earmarked for that purpose.

Questions about Cisco have never been about whether it will prosper -- they focus only on how much. After years in which the outfit seemed oblivious to the more painful aspects of competition, the news on Nov. 9 will give the "how prosperous?" questions a new resonance. Peter Burrows is computer editor in BusinessWeek's Silicon Valley bureau


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