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Cisco Scales Back Forecasts


Some investors fret the company is lagging in key sectors. Even if Cisco manages to do well in many of the new businesses it's targeting, they may not offer enough scale to make much difference

Unlike many of his tech peers, Cisco Systems (CSCO) Chief Executive Officer John T. Chambers refuses to admit that his 26-year-old company has lost its youthful vigor. While IBM (IBM), Hewlett-Packard (HPQ), Microsoft (MSFT), and other old-school technology titans stopped making bold long-term growth projections years ago, Chambers has told Wall Street since 2007 that his sales would increase 12 percent to 17 percent annually over the long haul, boosting his forecast from the 10 percent-plus growth he was predicting before then.

The downside to his optimism became clear on Nov. 10 when Cisco announced third-quarter earnings. Though the company turned in impressive results—sales grew 19 percent, to $10.75 billion for the quarter—shares got slaughtered when Chambers offered a growth forecast that fell far short of his typical bullishness. He's predicting less than 5 percent for the current quarter, although he expects a return to 12 percent or higher in coming years. The stock plummeted during after-hours trading and opened 16 percent lower the following morning. "The general consensus right now," says Ticonderoga Securities analyst Brian J. White, is that Cisco "can't hit Chambers' goals."

The revised forecast has raised concerns that Cisco is losing its focus. With its core business—selling routers and other Internet plumbing—expected to expand by about 9 percent a year, Cisco has been pinning its growth hopes on gear that creates new, byte-hogging ways of using the Internet. The company is working on nearly 40 such initiatives, including network-connected billboards, videoconferencing gear for the living room, and servers and routers tailor-made for data centers.

Chambers believes those projects could add up to a vast tech ecosystem. He says equipment for delivering movies and other entertainment via the Internet and collaboration tools such as videoconferencing will eventually be a $38 billion market. Smart energy meters that let utilities and consumers track power consumption minute-by-minute could be a $10 billion business. And equipment for data centers represents a $50 billion opportunity, Chambers has said. Despite the worldwide recession, Cisco has exceeded 12 percent growth in 5 of the 13 quarters since Chambers upped his sales target. That includes 27 percent in each of the previous two quarters this year.

The question is why Cisco now expects harder times even as smaller rivals such as Juniper Networks (JMPR) and Fortinet (FTNT) say they're powering ahead. Chambers insists the company continues to dominate the router and switch markets, which bring in 60 percent of sales. Other than troubles at subsidiary Scientific Atlanta, which makes set-top boxes for cable and satellite TV providers, Chambers told analysts on a conference call that the biggest problem was a sudden plunge in spending by state governments in the U.S. That's a serious issue for a company that makes 22 percent of its sales to the public sector. Chambers declined to be interviewed for this story.

Some investors fret that the company is lagging in key sectors. Cisco has long been a leader in computer security, a $20 billion market that researcher IDC expects to grow by 9 percent this year. Yet in the most recent quarter, Cisco's security sales fell by 2 percent. Cisco is trailing startups such as F5 Networks and Riverbed Technologies in some important niches in cloud computing, where processing power moves from a customer's PC to a distant data center. Cisco "is missing out on some things they should be doing," says Jane Snorek, an analyst with First American Funds.

Even if Cisco manages to do well in many of the new businesses it's targeting, they may not offer enough scale to achieve the kind of growth Chambers envisions in a company that expects sales of more than $43 billion for fiscal 2011. Cisco resuscitated the once sleepy videoconferencing industry in 2006 when it announced its first TelePresence systems. These high-end rigs cost $300,000 per installation but have proven popular because they offer video so real that participants thousands of miles apart almost feel they're in the same room. Since then, Cisco has brought out cheaper systems, and last year it paid $3 billion for market leader Tandberg. Still, Cisco's total videoconferencing revenue will be less than $2 billion this year. "It's not that Cisco doesn't have evidence to show they're succeeding in many markets," says former Cisco executive Jayshree Ullal, who is now CEO of router maker Arista Networks. "It's that none of them are large enough. The numbers just don't add up."

One market where the numbers might add up quickly is data centers, though in that area Cisco faces stiff competition. To break into the market, Cisco has developed what it calls the Unified Computing System, a server designed to work with its routers. While that product has been a success—Cisco has signed up more than 2,800 customers that have spent a total of nearly $500 million—it's still a tiny player in the $50 billion server market. And market leaders IBM and HP have started to sell both routers and networking gear, either their own or made by partners other than Cisco.

So to meet Chambers' ambitious goals, Cisco may need to keep making acquisitions with its $40 billion in cash. Since 2007, Cisco has bought 37 companies while HP has bought 28, Bloomberg data show. Without all the dealmaking, the company would have grown less than 10 percent in the past two years, figures Erik Suppiger, an analyst at investment bank Signal Hill. "It will be a challenge to achieve 12 to 17 percent growth on a sustained basis," Suppiger says. "I think they need to refocus on their core markets."

The bottom line: Investors are worried that Cisco may no longer be able to deliver the kind of growth it has in recent years.


Steve Ballmer, Power Forward
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