Here's part of Mansky's (C) report, which includes suggestions for people into options:
2 November 2007 ? 15 pages
Cisco Systems Inc (CSCO)
Carrier & Currency Offset US Enterprise and Japan
? Conclusion(s) —we view Cisco’s service provider strength and int’l exposure as
likely enough to offset a less than stellar U.S. enterprise and continued pushouts
from Japan. With reasonable estimates for January, we see minimal
“expectation risk” near-term. Although lacking re-valuation catalysts (Op.
Margin expansion) necessary for us to change our fundamental view, we
acknowledge that continued top line strength amidst the market trend toward
tightening leadership will likely be met with near-term appreciation. Maintain
Hold rating, price target adjusted to $34 or 20x our CY08 EPS of $1.71.
? Fundamentals — Cisco reports FY1Q (Oct) on Wednesday Nov. 7th post-close.
We view our roughly in-line with consensus $9.52B and $0.36 as potentially
$50-100M and $0.01 conservative, respectively. For January, we anticipate
Cisco can guide to at least our $9.8B and $0.38 estimates.
? Concerns — A) JNPR, FDRY, RVBD and FFIV all pointed to a less than brisk US
Enterprise; B) NGN (Japan) timing appears to be slipping further to the right.
? Tactical Edge — Options strategies around the quarter: To capitalize on our view of
average (but not extreme) November 5 earnings volatility: Sell Both the November
$37.50 call and $27.50 put. The strikes are 15% from the current stock price and
we have not seen an earnings move greater than 15% in 22 quarters. If CSCO is
within this range at option expiration in 12 days the return on capital is between 4%
- 5%, based on indicative pricing on November 2. The option market views this as
an 88% probability. See inside for details.
Near-term Upside Likely but Fundamental
Buy Catalysts Aren’t as Clear.
In an environment in which access to capital is in decline, more liquid and
higher quality companies will likely fare better. The recent run up in a number
of bellwether high tech names is testament to this narrowing of leadership.
Given our near-term view, we acknowledge this dynamic will likely drive
appreciation in Cisco shares. However, our fundamental view is unchanged in
that a move to the high $30’s is difficult to justify absent operating leverage,
even if the company achieves the top end of its 14% to 16% sales growth range
for fiscal 2008. Multiple uncertainties, taken in aggregate, further complicate
the prospect including: a) the pace of US Enterprise (12% of revs) spending in
2008; b) uncertainties surrounding service provider spending in Japan; and c)
the potential for set-top box inventory digestion post FCC 707 adoption.
Diversification Mitigates U.S. Enterprise
Concerns in October / January.
The U.S. enterprise accounts for about 12% of Cisco’s sales. Recent
September quarter earnings releases by a number of Cisco’s competitors show
signs of a potential slowdown of business in the U.S. Enterprise. Although not
all missed expectations outright, given offsetting business elsewhere, each of
Riverbed, Foundry, F5 and Juniper demonstrated softer than expected
performance from their enterprise-facing business units. Outside of the
networking space, IBM (25-30% exposed to financials) reported in-line
numbers but disappointing mainframe sales due to U.S. customer purchase
deferrals. At the same time, EMC reported total revenues slightly ahead of
expectations, but pointed to weaker than expected performance at the high
end, where large US enterprises and financial services are concentrated.
While the crisis currently taking place in the financial sector cannot be
discounted, we note that September/October is the seasonally weakest quarter
of the year for both the U.S. and European enterprise marketplaces and that
most of these vendors remain optimistic about the calendar 4Q.
In response to the broader concerns surrounding what appears to be a slowing
U.S. enterprise market, we performed a sensitivity analysis in order to ascertain
the potential impact on Cisco. We believe that in order for Cisco to miss
consensus EPS estimates by a penny, the U.S. enterprise would have to come
in 18% below our expectations; an unlikely occurrence in our view.
We estimate U.S. enterprise to be 12% of sales in the quarter in the base case
scenario, with 61% gross margins, and sales and marketing to account for
20.4% of its sales. We award the 100 basis point premium to corporate average
here to account for the fact that Cisco leverages a more direct and better
utilized sales model within the U.S. versus the rest of the world. An 18%
shortfall in U.S. enterprise would result in Cisco missing its top-line by about
$200 million, resulting in Cisco posting a 1% decline in sales versus the
expected 1% increase in sales. Should the U.S. enterprise sales come in 5% to
15% short of our expectations, the impact will be neutral to the EPS line, and
we believe Cisco has enough business momentum in its other business to make
up for the $50 million to $150 million shortfall.
[snip a LOT, to the end of the options strategy section]
We therefore recommend 2 potential trades:
1. Buy the $32.50 call and sell the $35 call, for a net premium paid of
$0.89 ($1.26 - $0.37), a maximum pay out of $1.61 ($35 - $32.50 -
$0.89 premium) a maximum return on capital of 181% ($1.61/$0.89)
and a maximum loss equal to the premium paid. We are
recommending the call spread because, while we are bullish we only
anticipate a 10% chance that the stock will be above the $35 price
level at option expiration, and thus do not want to pay for the right to
attain the upside above that level, even though the $35 call sold is
slightly low in value, comparing market price to our fair value price.
2. Sell both the $37.50 call and the $27.50 put for a total premium
collected of $0.16. While we would not normally advocate selling
options for such a small premium, we note that both strikes are 15%
away from the current stock price and that such a move would exceed
two times both the average historical 1-day earnings move over the
past eight quarters, as well as both the view of the option market and
our view of a 6.5% earnings move. Also, option prices imply an 88%
probability that the stock will be within the $27.50 to $37.50 range at
expiration. Looking back over a longer time frame, we note that over
the past 21 quarterly earnings announcements the largest 2 price
moves were 13% five quarters ago and 14% 21 quarters ago. One
would need to go back 22 quarters to see a price move in excess of
15%. Note again our 85% combined probability of a 5% move, a 10%
probability of a 10% move and a 5% probability of a 15% move. It is
essentially only the 5% chance of a 15% move that would be
detrimental to the proposed trade, as our strikes are 15% from the
current price.. The maximum return for this trade, if the stock finishes
between the 2 strikes at option, is 5%. For two weeks of exposure. The
5% return is the ratio of the $0.16 premium divided by the initial
margin of $3.22. This margin is calculated based on the distance of
the strike prices to the closing price of the stock on November 1. The
maximum return of this strategy is $0.16, while the maximum loss is
unlimited on the upside, and equal to -$27.34 on the down side
(premium less put strike).
[snip to end]
I have never tip toed into options, but there has been some discussion of them here lately so I included part of this section.
Lynn |
