Pro Research: Wall Street dives into Cisco’s strategic moves

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In the ever-evolving world of technology, Cisco Systems (NASDAQ:), Inc. stands as a stalwart, navigating through the currents of change with strategic acquisitions and a focus on software-driven revenue. However, the networking giant’s journey is not without its challenges, as industry analysts have observed some turbulence that could affect its trajectory.

Company Overview and Market Performance

Cisco, a major player in IT Hardware and Communications Equipment, has recently made headlines with its intent to acquire Splunk (NASDAQ:) Inc., a move poised to bolster its offerings in security, AI, and observability. This strategic decision is expected to enhance Cisco’s position with large customers and increase its recurring software revenue, which is a positive sign for the company’s future.

Despite this, Cisco’s stock has experienced volatility. After-hours trading saw a decline of over 10%, attributed to a downward revision of annual guidance by 6%, marking the third such cut. This adjustment reflects concerns about an enterprise slowdown and weak orders, which could persist rather than rebound as previously hoped. Analysts are wary, suggesting that the market’s expectations for Cisco for 2024-2025 may be overly optimistic.

Financial Performance and Analysts’ Ratings

Cisco’s recent financial results have been a mixed bag. For F1Q24, the company reported earnings per share (EPS) of $1.11 on revenues of $14.7 billion, surpassing estimates. However, the guidance for F2Q24 and FY24 was significantly below consensus, leading to a share price decline. Analysts have adjusted their ratings and price targets accordingly, with one firm setting a target at $50 and another at $46, both decreases from previous targets.

Competitive Landscape and Industry Trends

The networking sector is facing a downcycle, which could negatively impact Cisco and its peers. The company is contending with stiff competition from firms like Arista, which is vying for market leadership in ethernet AI networking. Cisco’s ability to gain share in key growth infrastructure markets remains a concern, despite recent momentum in areas like AI networking.

Strategic Acquisitions and Prospects

The acquisition of Splunk is seen as a medium-term benefit, enhancing Cisco’s capabilities in observability and AI networking. Cisco has over $1 billion in AI networking projects in sight for FY25, indicating a strong focus on this emerging market. The company also boasts record gross and operating margins, reflecting cost management and a shift to high-margin software.

Bullish and Bearish Perspectives

On the bullish side, Cisco’s leadership in the nascent webscaler AI networking market and strong performance in the observability technology segment and SMB sector are seen as significant growth opportunities. However, the bearish view points to concerns about Cisco’s ability to gain share in key markets and the potential impact of the Splunk acquisition on financial flexibility.

Bear Case

Is Cisco’s enterprise slowdown a long-term concern?

The repeated reductions in Cisco’s annual guidance and the significant decline in orders suggest a protracted enterprise slowdown. Analysts note that customers’ excess inventory and the normalization of backlogs could lead to a sustained period of weak orders. The company’s efforts to navigate through these headwinds include a focus on AI networking and observability, but the full impact of these strategies on reversing the slowdown remains to be seen.

Can Cisco maintain its market position amid competitive pressures?

Cisco faces increasing competition in the networking industry, with competitors potentially gaining market share. The company’s ability to maintain its leadership position is challenged by the need to innovate and adapt to changing market demands. While Cisco’s acquisition of Splunk could provide a competitive edge, integration risks and the potential dilution of focus within crowded markets like SIEM, APM, and NPM add to the uncertainty.

Bull Case

Will Cisco’s strategic focus on software revenue pay off?

Cisco’s acquisition of Splunk is expected to significantly expand its software revenue, aligning with broader industry trends that favor Cisco’s solution sets. Analysts are optimistic about the long-term benefits of this strategic focus, as it leverages Cisco’s strong customer base and aligns with the shift towards recurring revenue models.

How will Cisco’s AI networking projects impact its growth?

With a clear aim to dominate the AI networking space, Cisco has set its sights on achieving $1 billion in AI-related orders by FY25. This ambition, coupled with the company’s strong performance in F1Q24 and high gross margins, presents a bullish case for Cisco’s growth potential in the second half of the fiscal year and beyond.

SWOT Analysis

Strengths:

– Leadership in AI networking and observability technology.

– Strong financial performance with high gross and operating margins.

– Strategic acquisition of Splunk to enhance software offerings.

Weaknesses:

– Repeated downward revisions in annual guidance.

– Inventory buildup leading to order declines.

– Integration risks associated with the Splunk acquisition.

Opportunities:

– Growth potential in the webscaler AI networking market.

– Shift to high-margin software and recurring revenue models.

Threats:

– Downcycle in the networking industry.

– Competitive pressures from peers in key growth markets.

Analysts Targets

– Piper Sandler: Neutral rating, price target of $50 (November 16, 2023).

– JMP Securities: Market Perform rating (November 16, 2023).

– Barclays: Equal Weight rating, price target of $46 (November 16, 2023).

– Morgan Stanley: Positive outlook indicated (++), specific price target not provided (November 16, 2023).

– Raymond James & Associates: Market Perform rating (October 30, 2023).

– Evercore ISI: Outperform rating, price target of $55 (November 16, 2023).

– KeyBanc: Sector Weight rating (September 22, 2023).

– Deutsche Bank: Hold rating, price target of $54 (November 16, 2023).

This article is based on analysis from September to November 2023.

InvestingPro Insights

As Cisco Systems, Inc. continues to adapt and expand its business through strategic acquisitions and a focus on software-driven revenue, real-time data and insights from InvestingPro provide a deeper look into the company’s financial health and market performance. With a market capitalization of $196.59 billion and a P/E ratio standing at 14.58, Cisco showcases a stable investment profile.

InvestingPro Tips highlight that Cisco has a perfect Piotroski Score of 9, indicating a strong financial position, and the company has been successful in raising its dividend for 13 consecutive years, reflecting a commitment to returning value to shareholders. Additionally, Cisco’s revenue growth has been accelerating, growing by 10.99% over the last twelve months as of Q1 2024, which is a testament to the company’s ability to drive top-line growth even in a challenging market environment.

Investors considering Cisco will find it reassuring that the company operates with a high return on assets (14.16%) and that analysts predict the company will be profitable this year, having been profitable over the last twelve months. Moreover, with a dividend yield of 3.23% as of the end of 2023 and a fair value estimate of $54, which is in line with InvestingPro’s fair value of $54.64, Cisco appears to be trading at a value that reflects its earnings potential and market position.

For those looking to delve deeper into the investment prospects of Cisco, InvestingPro offers a comprehensive suite of additional tips, including insights on the company’s high earnings quality and cash flow strength. In total, there are 18 additional InvestingPro Tips available for Cisco, which can be accessed through a subscription. As a special offer, the InvestingPro subscription is now on a Cyber Monday sale with a discount of up to 60%, and readers can use the coupon code research23 to get an additional 10% off a 2-year InvestingPro+ subscription.

Whether you’re evaluating Cisco’s market position, financial metrics, or strategic initiatives, these insights and additional tips from InvestingPro can help investors make informed decisions and potentially enhance their investment strategy.

This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.