Whither Cisco?...
Wednesday February 14, 6:00 am Eastern Time
Morningstar.com
By Pat Dorsey
<<I haven't dug into the e-mailbag recently, but the following timely question from Jeff Kopp deserves a response:
``You've been harping on what a slam-dunk Dell (Nasdaq: DELL - news) is in the low $20's, but what about Cisco (Nasdaq: CSCO - news) at its current, or potentially lower levels? It is 64% off its high, and continues its descent as I am writing this e-mail. It seems to me that if it reaches the mid-$20's it would be as much, if not more, of a slam-dunk than Dell. It seems like it would be a good long-term buy now, or a great long-term buy if it continues to decline.''
Harping, Jeff? Now, now, just because I happen to think a company growing at 15% to 20%, with a reasonable valuation, and a return on invested capital north of 300% is a heck of an investment idea, there's no need to use words like harping\205but that's neither here nor there. The company before the jury today is Cisco.
To me, there are three basic issues surrounding Cisco's future--and I'll warn you ahead of time that there are no clear answers to any of them. The first one is largely short term: When will the economy bounce back? Second, just how bad is the competitive environment right now, and how much worse is it likely to get? Finally, can Cisco once again stomp all over the Law of Large Numbers and grow a $26 billion top line at between 30% and 50%?
Since the first question is essentially a short-term issue (not to mention being fundamentally unanswerable), I won't spend too much time on it. However, those of you who are thinking of dipping your toes in the Cisco pond should bear in mind that if the economy doesn't bounce back strongly in the second half of the year, you might see the shares go a lot lower than $30. Even way down here, Cisco still trades at about 45 times its calendar-2001 earnings estimates after a brutal round of estimate reductions. That's not cheap by any means, especially when the ``E'' in the ratio could be at risk for a further slide if Alan Greenspan's medicine takes longer than expected to get the economy moving again.
Of course, if you're looking out six years instead of six months, the near-term state of the economy isn't that big a deal--I don't think anyone's looking for a Japan-in-the-1990s situation in the United States. Competition, however, is a very big deal over the long haul, and companies like Juniper (Nasdaq: JNPR - news) and Extreme (Nasdaq: EXTR - news) have been making serious inroads into some of Cisco's markets. Juniper, in particular, has come from virtually a standing start to take 30% of the router market in just two years.
The key thing to remember, however, is that Cisco has such a broad product line that weakness in any one area is not going to make or break the firm's future. It's a worry, to be sure, and companies like Juniper, Extreme, and Redback (Nasdaq: RBAK - news) will always be looking for chinks in the giant's armor. No other company can be as much of a one-stop shop for its customers' networking needs, and few other companies match Cisco's balance-sheet strength or market- cap size--both of which are competitive advantages in winning customers and in staying ahead of the technological curve through acquisitions.
But size can be a hindrance, as well as a help, which brings us to the third of Cisco's challenges: They're driving an 18-wheeler at speeds usually reserved for sports cars. For example, if Cisco hits the low-20% top-line growth rate that it's targeting for the coming fiscal year, it will pull in something in the neighborhood of $32 billion in the fiscal year ending July 2002. Currently, the company believes that it will return to its historical growth rate of between 30% and 50% between 2002 and 2004. If Cisco grows at the low end of that range between 2002 and 2003, for example, it will need to pull in an incremental $10 billion in revenue--or $2.5 billion each quarter. Growing a company so large at such a fast pace is not going to be easy, and even CEO John Chambers put the company's odds of success at only 70% in a recent interview with Fortune.
So, if you're willing to take those odds, and hang onto the shares through what could be some choppy waters, buying the shares under $30 seems like a reasonable idea, given that Cisco's current P/E multiple relative to the S&P 500 is pretty much in line with its historical average. The risk that the Cisco of yore will not re-emerge from the current economic slowdown is very real, though, so don't kid yourself that the shares are without substantial risk even after falling from $80 to $30. Even now, the market is expecting some pretty big things from Cisco over the next
few years.>>
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BTW, CSCO is not the only Gorilla having a tough time holding on to its premium valuation. This is a new market with LOTS of impatient investors and a FED that's behind the curve...JMHO <G>.
Best Regards,
Scott |
