Nine Cisco Questions
Board: Cisco Systems
Nine questions gets you a novel as an answer.
1) How much market share has CSCO lost on routers in the last years ?
That sounds like a simple question to answer, but it isn't. Which router market are you talking about? Carrier core routing is a different market from carrier edge routing which is a different market from enterprise edge and core routing.
On the carrier edge, Cisco has been losing share to Alcatel - not Juniper. In fact, Juniper has been losing share to Alcatel as well in that space. The easiest numbers I could find were from Brad Reese, but they're always a bit suspect given that he has an enormous built in anti-Cisco bias and has for years. As an aside, the guy to totally annoying. Cisco could find a cure for cancer and he would write an article about how Cisco neglected to find a cure for AIDS. In any event, he says that Cisco lost around 9% share in 2011 in the carrier edge space. Chambers was questioned on that and blamed it on product transition. As Cisco ramped down the 7200 series routers and ramped up the ASR 1K and ASR 5K, it caused disruption which created an opportunity for competitors. Time will tell if he's right.
In the carrier core, they're still battling hard against Juniper and Alcatel and have lost some market share over the years. Over the last 5 years, Cisco has declined from 57% to 40% share. Juniper has around 19%. Alcatel has around 26%. I'm not sure of all the factors driving that market share shift, but I would think Cisco's premium price coupled with a pounding US recession and declining carrier revenues from traditional revenue sources probably had a lot to do with it. We'll see if Cisco can turn that around.
In enterprise routing, according to Del Oro Group, they still hold roughly 82% market share. That's a smaller market than the service provider core, but it's worth pointing out.
So Cisco is struggling in the service provider core. I would blame a combination of product mix, product transition, and premium pricing at a time when these customers couldn't afford it.
At the same time, you need to factor in that these market share losses affect a market that all in accounted for roughly 15% of Cisco's revenue. 15% is nothing to sneeze at, but it helps keep the share loss in perspective relative to the whole company.
2) Are there competitors, like for example Juniper growing much faster ? Are they overvalued ?
There will always be competitors growing much faster. Arista, Juniper, Aruba, Palo Alto - they'll all grow faster because they are growing a much smaller revenue base. Look at the core routing numbers for a minute. I mentioned above it was a $12.8B market. Juniper has around 19% share. Cisco has around 40%. Let's say the market grows $1B. Juniper picks up $200M on a revenue base of $4.85B - 4% overall growth from that small jump in revenue. Cisco picks up $400M on $42B - just under 1%. Juniper grows faster, even without growing market share and even though Cisco made more actual cash.
Does that make Juniper a better investment? I'm not so sure. It's projected to grow 18% versus Cisco's 5%. Of course it's trading at 28x earnings so the growth is already factored in. They have less market diversity and much less cash on hand to weather a downturn.
You're right that it's worth looking at, but the key is that Juniper and Cisco are different types of companies. Cisco is a large, mature player - more like a GE. Juniper is smaller which gives it a more explosive upside but also more risk. It's up to an individual investor to figure out which tpe of investment works best for them.
3) How bad is the situation with the switching margins ? Will the strategy of creating new products be enough to offset the price declines ?
Switching margins declined 4% if I have my numbers correct. That was due to a combination of competitive pressures and and sales strategies built around subsidizing the introduction of strategic products into accounts.
On the competitive front, that isn't going to slacken any time soon, but there may be some relief from HP. Their "catalyst for change" promo was a money loser (i.e. the deals carried negative margins to win share) and Apothekar recently announced the end of negative margin deals at HP, so we may see pricing stabilize there.
From a product mix perspective, the switch to Nexus for data center switching also had a significant impact on margins. The Nexus line doesn't have the run rate the Catalyst line does yet and the result is lower margins for that product right now. That said, it is the strategic direction for core switching for Cisco right now and so sales teams have been pushing that product regardless of the impact on margins. That should stabilize over time as well.
4) Is it true that the council system caused a top quality management exodus towards competitors and a slow decision making bureaucracy from which the company never recovered ? Can restructuring amend the situation ?
The council and boards system was an atrocity and it was definitely at least partially responsible for several key players (Yes, I'm looking at you Jayshree) leaving the management team. I think Chambers brought that to life to address concerns about succession. There was no clear replacement for John in the wings and people were justifiably concerned about what the plan was when John got hit by a bus. I think the councils and boards thing was an attempt to devolve decision making below the CEO level to address that concern. It also was intended to mollify key managers who were hoping to be tapped as the next CEO. There was no clear post that had a direct line to follow John in this model.
Can it be fixed? I hope so, but it's going to be tough. I think it risks the exodus of more key people as it becomes clear they aren't in line for the throne. Either way, they have to fix it - it was a disaster. I worked in a matrixed organization many years ago. I could have told John what he was trying to do was going to be a disaster. If only he had called. :-)
5) Why is John Chambers the ceo so unpopular, is it related to 4) ?
10 years of negative returns on the stock coupled with a love of being a celebrity CEO and an arrogance that everything would come out okay no matter what stupid idea he tried because Cisco was just that good have made him unpopular.
It's well deserved, to be honest. He was much better when he was focused on beating competition and less focused on jetting off to meet with the Prime Minister of India.
6) How many employees will be fired with the current restructuring process, what are the associated write downs ?
I think the number they released to the street was 4000, but I'm not sure. I think you can expect the restructuring costs to be fairly significant. I'm not close to it, but for back of the envelope calculations I would estimate it at $300M or around $.05/shr in the qtr it happens. Of course, that should result in roughly that amount in savings over the course of the year, so the full year impact on earnings should be negligible.
7) Is the pricing power still good ?
Yes. While it's not as good as it was a decade ago, it's still very good. Cisco can routinely command 20-25% price premium over their competitors. That depends on market segment and product mix of course, but as a long term average, 20% is a good number to use.
8) What is CSCO biggest competitive barrier, what do they do that their competitors are still not doing ?
a) End to end architectures - one platform to support all your IT needs. Integrated solutions that address LAN, WAN, wireless, security, voice, video, servers, management, and so forth. Guaranteed compatibility and ease of integration. No competitor is well positioned to provide a broad range of integrated solutions with a single throat to choke.
b) Channel - Cisco has very strong relationships with their channel partners. Most competitors either don't have an effective channel or they have alienated them through a combination of low margins and direct competition. Cisco's channel is a force multiplier.
c) TAC - follow the sun support. Spare parts and knowledgeable people available in even some of the remotest places on the globe.
9) Has CSCO made an error trying to take on the server market competing against its own clients such as HP an Dell ? Was it not a necessary survival move since their competitors were also getting into CSCO's network business ?
Cisco has risen to 20% market share in x86 blades in the US and 9% overall globally. They are #2 in the US behind HP and #3 in the world behind HP and IBM. They are soundly beating Dell.
They did not make a mistake getting into the server business. They have- for the moment anyway - an architecturally superior product that can be clearly differentiated from their competition. Furthermore, there is a huge growth opportunity in cloud services and to play in that market as a hardware provider you need to sell servers. If Cisco had chosen not to get into the server market, they would have missed the transition to cloud which would have eviscerated their data center switching business and left a huge hole in their revenues.
And you hit the nail on the head - Cisco had to get into servers. Competitors were already trying to reduce the number of switch ports in the data center, first with a customer migration to 10G ethernet for virtualization and then by eliminating switching in the blade enclosures themselves (HP Flex 10 and virtual connect).
So getting into servers made sense on a couple different levels and it seems like Cisco is doing well there from a share perspective.