Bill Fleckenstein: The Market Rap:
... And we would be remiss if we did not point out that we have a G8 shrimp-fest this weekend. I would not expect much to come out of this, but folks need to know that it's going on. Lastly, in the lost credibility department, there is a good article* in The Wall Street Journal, in the C section, right below the aforementioned Merrill Lynch article. It chronicles the Cisco travails, and illuminates what happens when someone loses credibility as Mr. Chambers has. It winds up by quoting Paul Sagawa from Sanford Bernstein: "A lot of investors would feel more comfortable by management that was more realistic." Amen to that.
*WSJ: Heard on the Street: Cisco Expects 'Tornadoes' To Fuel Revenue Growth
By DAN GOODIN
Staff Reporter of THE WALL STREET JOURNAL
With revenue at Cisco Systems expected to shrink during the coming fiscal year, in what will be a first for the company's 17-year history, it is clear to many investors that the Internet-equipment company is entering a new era as a slower-growing, middle-age adult.
Few investors doubt Cisco will grow again. The big question: how much?
Cisco Chief Executive John Chambers insists his company's revenue can grow 30% to 50% annually for three to five years, once the industry recovers from its slump. He contends the industry will grow by 30% to 50% a year -- and "if it isn't us, it will be somebody else." Michelangelo Volpi, Cisco's chief strategy officer, says Cisco is competing for a piece of a market valued at $150 billion. "There's a lot of room to grow," he says.
But Cisco's assertions are drawing voices of doubt that sometimes verge on ridicule. "If there's one question I get from investors it is ... 'Is it feasible for Cisco to return to 30% growth?' " Greg Geiling, a J.P. Morgan analyst, says. He estimates that a more realistic figure is 15% to 18% annually during five years. A.A. Tad LaFountain, an analyst at Needham & Co., says Cisco will be unable to hit Mr. Chambers's target "unless they're invoking extraterrestrial shipments."
Why the skepticism? Basic math, for one. Cisco -- the world's largest maker of Internet-switching gear -- is expected to record revenue of $22.3 billion for the fiscal year ending July 28. To grow 30%, Cisco has to add revenue of $6.7 billion, roughly equal to the annual revenue of America Online before merging with Time Warner to form AOL Time Warner. To do it again the following year, Cisco would have to add revenue of $8.7 billion, more than the annual revenue of Apple Computer.
No technology company with more than $20 billion in revenue has been able to grow the way Mr. Chambers says Cisco can, UBS Warburg analyst Nikos Theodosopoulos says. The closest runner-up: Hewlett-Packard. Topping $20 billion in sales for 1993, it grew at an annualized 23.4% during the next three years, before contracting in 1997.
The debate about Cisco's growth rate is far more than academic. Investors pay a premium for companies with fast-growing earnings. Mr. Theodosopoulos puts Cisco's 12-month share-price target at $20, based on 25% to 30% growth during fiscal 2003, which will start July 28, 2002. If he believed Cisco were going to grow at 40%, he says, he likely would value the company 40% higher, at $28.
In 4 p.m. Nasdaq Stock Market trading Thursday, Cisco shares were up 61 cents to $17.76. That leaves Cisco shares nearly 75% off the 52-week high of $70 hit during August, and roughly 35% above April's low of $13.19. Beyond concerns about the growth stall that typically occurs as a company gets bigger and bigger, there is a view taking hold that Cisco's business is in the midst of a major transition. The slowdown is crippling some of Cisco's most promising customers and new markets, such as upstart telecommunications carriers. A year ago, Cisco was selling to 3,000 upstart telecom companies; today that number is 150. As companies such as 360 Networks and PSINet wither, there is less incentive for incumbent carriers like AT&T and WorldCom Group to spend heavily for networking gear.
Until the slowdown, Cisco rarely faced such thorny questions. Cisco's revenue jumped more than eight times during the past five years, from $2.2 billion for the fiscal year ended July 1995 to $18.9 billion for the year ended July 2000, or an average of 54% each year. As recently as last year, analysts predicted annual growth of at least 30%, as they counted on corporations and telecom carriers to continue massive expansions of communications networks.
The world looks very different. How badly will sales be hit during the fiscal year beginning this month? A consensus of 28 analysts surveyed by Thomson Financial/First Call predicts Cisco's revenue to decline by 6.7%.
For their part, Messrs. Chambers and Volpi are betting "tornado" markets will spur new business this decade, much the way the Internet opened a torrent of new opportunities during the past one. The tornado markets include Internet-based phone systems for businesses, wireless networks for homes and offices, Internet-based systems to streamline the way corporations store data, and gear that reduces Internet-traffic congestion by putting copies of popular digital content on computers in multiple geographic locations. A fifth twister is the gear for building metropolitan fiber-optic networks, the speedy on-ramps that connect long-haul networks to local traffic centers. Cisco conservatively estimates these markets at $20 billion, and $40 billion by 2004.
Cisco's target also assumes that demand for its core business -- networking gear used by medium-size businesses and large corporations -- will grow by at least 13% and that it can increase its market share in markets such as the one for industrial-strength routers used by large telecom companies. Blending the new revenue from tornado markets with growth in Cisco's core markets and increased share in other markets, "30% growth does not seem unachievable," says Hasan Imam, a Thomas Weisel analyst who recently set Cisco's 12-month target price at $30.
Cisco also sees room for optimism in the severe problems confronting just about every major competitor. "It is an industry that is going to consolidate, and nobody is better at consolidation than Cisco," says Mr. Chambers, who is fond of reminding the world that he has $17 billion in liquid assets, while most of Cisco's competitors are wallowing in debt.
But Cisco's analysis makes some big assumptions, namely that the tornado markets, in fact, will take off as expected and that Cisco can become a dominant force in most, if not all, of them. What is more, not all analysts are confident Cisco's core business will grow. Sales of routers account for 40% of Cisco's revenue, Mr. Theodosopoulos estimates. "How do you know the router market isn't going to be a 5% grower" in future? he asks.
Also fueling the skepticism, Cisco refuses to forecast exactly which markets will generate the huge growth it hopes to achieve, saying the precise mix five years out is bound to differ radically from whatever figure is forecast. That vagueness in justifying Cisco's 30% to 50% growth target has frustrated even loyal investors.
"There is a credibility issue, especially as you get into the higher end of that range," Walter Casey, a buy-side analyst at Banc One Investment Advisors, says. Mr. Casey, who describes Cisco as an "important" holding, says Mr. Chambers "has got to come up with something specific here." Some even go so far as to say an admission from Mr. Chambers that Cisco's long-term growth is likely to be more modest would only help the company's stock.
With shares well off their dizzying highs, they say, investors no longer assume the bullish growth rates they did. "Nobody, not even the most bullish investor, believes Cisco can grow by 30% to 50%," Paul Sagawa, an analyst at Sanford C. Bernstein & Co., says. "A lot of investors would feel more comfortable by management that was more realistic."
Write to Dan Goodin at dan.goodin@wsj.com1
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