Chris Lau - Seeking Alpha

Thursday, February 17, 2011

Cisco Systems

Cisco Systems, as investors already know, designs, manufactures, and sells Internet protocol (IP)-based networking and other products related to the communications and information technology industry worldwide (source: Yahoo Finance).

When the company reported earnings that greatly disappointed the markets, the stock fell considerably. Cisco Systems is failing, because it is getting too big, its product line too large, and the company appearing unfocused. Competitors are succeeding in markets where Cisco neglected, namely Riverbed and Blue Coat Systems. See chart below.

After reviewing its quarterly results during the quarterly earnings call, management was guiding analysts on the upside, over the longer term.

It will take some time for its new products to ramp up, for margins to improve, and for profitability grow.

On Seekingalpha, there was a debate on Cisco. Is the company undervalued? In the article, one comment that stood out was this one, by user NetEng. Once in a while good opinions pop out. It is like finding a needle in the haystack:

Most analysts do not comprehend the extent of Cisco's technology, which is exemplified by the Trefis chart in the above article. Add to that Cisco's upper management doing a poor job of explaining Cisco's new technology, and the result is that many analysts are commenting on and evaluating the Cisco of the past, and, moreover, using a technological framework that is fast receding into history.
Take the notion that Cisco is a "router and switch" company. While Cisco has done and continues to sell Ethernet switches, the data center model based upon top-of-rack Ethernet switches with multiple 1U servers is now becoming obsolete, especially to Cisco. The key technology is the Unified Computing System (UCS) which along with the Nexus 1000V virtual software-based Ethernet switch, can and will eliminate the top-of-rack/multiple physical server data center as we know it. The top-of-rack Ethernet switch is the technology targeted by HP and others. But for Cisco, there no longer exists a top-of-rack Ethernet switch, as it is now replaced by the Nexus 1000V virtual switch. The UCS system, using VMWare virtualization is able to replace the physical servers. Who supplies the physical servers today? Primarily HP, Dell, and IBM. So UCS is a direct threat to the server vendors' data center market.
Also Cisco, along with Brocade, is a major player in Storage Area Networks (SAN) technology, sharing the market with Brocade for the large Director class SAN switch technology at 50/50%. Many SAN innovations have been invented by Cisco over the past 7 years, such that it is fair to say that, contrary to most analysts perceptions, there are only 2 players in the SAN market: Brocade and Cisco.
Why is UCS important? By virtualizing physical servers, and eliminating top-of-rack physical Ethernet switches, a 5000 square foot data center can be shrunken into a 250 sq ft area with consequent electricity, cooling, and space savings. Think vacuum tubes vs transistors, when conceptualizing UCS/Nexus 1000V vs existing physical servers and top-of-rack Ethernet switches.
Senior Cisco management, simply has not gotten the word out, and analysts often speak in so much generalities that it is clear that they don't really understand what they are commenting on. How many data centers have most analysts built, for instance?

Finally, the economy is really, really bad, despite the rosy picture painted by most commentators. Reduced profits, smaller margins, are classical symptoms of a macroeconomic lack of demand, and warning signs of deflation. The Fed, and many economists are still sounding the cry that the economy is still very bad, and possibly getting worse. So, an alternative view is that Cisco is not losing market share, but still has the same share of a shrinking market ( think state and local government austerity cuts, which eventually hit Main Street).

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