Tech investors have seen a slew of warnings over the last few months, so Cisco Systems, Inc. (NASDAQ:CSCO)’ recent ‘beat’ was always likely to be well received. As ever with bellwethers, there is as much interest in what its constituent segments mean to the tech industry as there is in its own prospects. Moreover, as Cisco Systems, Inc. (NASDAQ:CSCO) is reporting late in the quarter, there may be some indication that the tech market is going to recover from a weak calendar Q1.
Cisco cheers the Market
After heavyweights like International Business Machines Corp. (NYSE:IBM), Oracle Corporation (NASDAQ:ORCL), and basically any company that sells anything to service providers delivered disappointing numbers, investors were entitled to expect Cisco Systems, Inc. (NASDAQ:CSCO) to miss as well. However, the company has always been a little different than others thanks to
1). the strength of its government-based business (which made it relatively weaker last year as austerity measures crimped expenditures). This can cause some lumpiness in results.
2). a huge cash pile with which it can invest to buy growth. Indeed, acquisitions have always been a major part of the strategy.
3). Its ability to bundle solutions together in order to generate growth across all segments.
I think these factors need to be understood before looking at the results. In summary, I think its core business of switching, routing, and services was a little bit disappointing. The good performance was in the non-core activities where acquisitions and the ability to bundle solutions may well have helped out. Nonetheless, this was a positive report overall for the tech sector.
On a geographical basis, the Americas grew 7% with some surprising strength in its U.S. commercial business, which was up 10%, and in a bullish marker for the tech industry, its U.S. enterprise numbers were up 10% with service provider-based revenue up 10%. In fact, this is a continuation of the strength that Cisco Systems, Inc. (NASDAQ:CSCO) saw in the last quarter with regards to U.S. enterprise.The U.S. public sector grew 5% with local and state growth of 13% counteracting a 3% decline in Federal.
EMEA was flat with some signs of ‘bottoming out’ being cited. Asia-Pacific was somewhat more disappointing with only 1% growth and some Cisco Systems, Inc. (NASDAQ:CSCO) specific issues were cited in China.
Cisco’s core business
You can access a review of Cisco’s previous numbers in an article linked here. Switching was a bit weaker than I had expected because previously, it had said that switching revenue would be flat for this quarter and the next. Routing revenue was flat year on year but saw a nice sequential increase from a disappointing quarter in Q2.
Services revenue growth was only 7%, and this reflects the lower growth profile that the company has had in the last couple of years. It calls into question whether Cisco will hit its 9%-11% CAGR target for services in the next 3-5 years.
A graphical depiction of these segments growth depicted below.
Having looked at what Verizon Communications Inc. (NYSE:VZ) said recently over its enterprise customers’ spending patterns and their ongoing cost cutting first based approach, it is no surprise to see Cisco’s switching and routing revenue entering a period of weakness. Switching had a stronger quarter in Q2, but in common with the rest of the industry, this quarter delivered a weaker set of numbers. For Verizon Communications Inc. (NYSE:VZ) investors, Cisco’s positive commentary on enterprise spending must be a plus going forward.
Whereas Verizon has rolled out much of its next generation network, AT&T Inc. (NYSE:T) is supposed to be playing catch up. However, in its last results, it announced that its capital spending plans would be reduced by 9% for the next two years. This is clearly disappointing because it was one of the service providers that the market was hoping would give a lift.
So, if the core results were a bit disappointing, where was the good news?
Cisco grows its non-core revenue
For a mix of reasons there was better news in its non-core activities. Starting with Service Provider and Collaboration.
While the SP Video results look great, they were largely a consequence of the NDS acquisition. This is no slight on Cisco, because the idea that it can use its cash pile to buy growth is a big plus point, but it does suggest that it should make more acquisitions. Unfortunately, poorly timed acquisitions in the collaboration sector may well have dimmed the market’s confidence in its strategy. Speaking of collaboration, it saw conferencing rise 11% but there was more ‘softness’ within telepresence as it continued to decline.
It is, therefore, somewhat puzzling to see Polycom Inc (NASDAQ:PLCM) rising in sympathy. I think this end market may well face some structural challenges in the next few years. IT spending trends are favoring mobility, open source platforms, and cloud-based solutions rather than hardware that ties purchasers to do things like use a fixed room within a location in order to engage in ‘telepresence’.
Turning to Wireless, Security, and Data Center, it is here that we can see the strength in these results.
Data Center has been a stand out performer for Cisco for some time, and its unified data center strategy is enabling it to offer integrated solutions to its customer base. Moreover, Cisco is executing very well in wireless. Telco budgets are shifting from wireline to wireless and it is essential that Cisco takes advantage of this. In particular, its service provider wi-fi growth was quoted as being ‘extemely strong’ while its wireless local area network group was up 17%.
I read this as a positive for a stock like Ixia (NASDAQ:XXIA). Not only is Cisco a major customer, but the company’s test, assess, and monitor solutions are well placed to take advantage of enterprise spending on wi-fi and LANs. If Cisco is rolling out more networks, then Ixia should be well placed to benefit from spending on making sure those networks function effectively.
The bottom line
Frankly, in the current environment, the market will take a lot of heart from these results and the relief rally is evident. Cisco didn’t beat by much and its EPS guidance of was in line with analyst estimates, but it has been such a tough quarter for tech and Cisco’s commentary (particularly on U.S. enterprise spending) was positive.
In reality, it was a mixed performance with its core businesses demonstrating sluggish growth, but the strength in its non-core activities is pointing the way to the future. In short, Cisco needs to use its cash pile to make acquisitions. The good news is that it can, and consequently, it still presents a decent value proposition.
The article Cisco and How Its Results Read Across the Tech Sector originally appeared on Fool.com and is written by Lee Samaha.
Lee is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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