OT - Very good freebee newsletter, good discussion of CSCO.
The High Tech Arena
2/7/99
By Joe Arena Editor
In keeping with our discipline of concentrating assets only in the best ideas, we continue to focus on the phenomenal results and growth potential at Cisco Sytems. We were favorably impressed with the conference call last week, and following are some of the key points relating to the call which augur wellfor the future.
At the risk of beating a dead horse, we reiterate that the exponential growth of the Internet is the reason to own Cisco. Remember that according to Cisco, there are seven new Internet users every second. This now equates to about 4 million web sites, 3.5 billion page views daily, and 235 thousand new web sites each month. Consequently, it was not surprising that the business driving the most significant growth at Cisco is the Internet Service Provider Market, which grew over 50% versus last year in terms of revenue.
This market now represents about 30% of Cisco's total business. It is also important to note that there was strength in every facet of this business. Specifically, DSL (digital subscriber lines), multiservice switches, cable, optical, and access realized double digit growth sequentially. The dial access platform space showed phenomenal growth, with orders growing over 20% sequentially. Going forward, expectations are that the service provider space will be the major catalyst enabling Cisco to maintain growth exceeding the networking industry.
Cisco's exceptional new product pipeline resulted in 13 new product introductions during the quarter. New product introductions should continue at an accelerated pace over the next several quarters. Of particular importance is the fact that Cisco is gaining market share in LAN (local area network) switches. It is estimated that Cisco's share of the market for LAN switches is now 50%. The most recent new products in this space contain enhancements for voice and IP (Internet Protocol) telephony, and will also be a large contributor to top line growth. Cisco also continues to deliver outstanding results in the enterprise market as well as the small and medium enterprise market. Growth versus last year in these segments in terms of revenue was 30% and 35%, respectively.
Over the course of the past year, global economic concerns provided the impetus for a major correction in the price of Cisco stock. These fears proved to be unfounded, and recent results should allay these worries even further. Geographically, Cisco's business in the United States and Europe remains in excellent shape, (Europe increased 10% sequentially and a whopping 50% versus last year) and the indications are that Asia has bottomed. There has been a great deal of publicity regarding the major commitment that Cisco has made to building its business in China, these investments should really start to add to both the top and bottom line over the next 3-5 years. (remember, during this time China is projected to become the second largest PC market in the world) Of equal importance is Japan, where bookings have strengthened decidedly, and are now increasing at the same pace as other regions.
From a long term strategic standpoint, Cisco's vision is to capitalize on the home networking market. Although this business is currently small (only 18 million households have more than one PC), the potential here is phenomenal. As we have discussed in previous articles, the method in which consumers access the Internet in the future will evolve from a PC centric paradigm to a variety of Internet enabled devices. Notwithstanding, Cisco will capitalize on the digital connectivity trend regardless of how this scenario plays out. To accomplish this, Cisco is concentrating its efforts on increasing adoption of broadband access in the home by reducing prices on cable and DSL modems.
Moreover, Cisco will exploit one of its core competencies by partnering with service providers to bring personalized high speed Internet access to consumers. In addition, to ensure that home networking becomes pervasive, Cisco will license its technology to leading consumer electronics companies. Cisco has already locked up deals with such stellar companies as MCI Worldcom, Sony, Sprint, and Samsung. The exceptionally strong balance sheet of Cisco is another salient reason to own the stock.
Cash and equivalents now equal $7.3 billion, an increase of $800 million, with no long term debt. Cisco is very astutely leveraging the strength of its balance sheet to accommodate customer financing needs. A focal point of this strategy is to increase operating leases. The advantage of this is the ability it provides to smooth out revenue recognition, which provides increased earnings visibility for investors. It should also be noted that total lease financing doubled sequentially in the January quarter to $600 million, underscoring the commitment that Cisco has to executing this strategy.
Certainly, Cisco's ability to defy the law of large numbers is probably the most compelling argument for the lofty valuation that Wall St. places on this company. The fact that an $8 billion company can grow the top line 40% also lends credence to the theory that "it really is different this time." Although there have been many times throughout history when this philosophy being espoused by a preponderance of investors was a sign of a market top, there are also certain times when a dramatic paradigm shift rendered this cliche correct. The invention of the wheel, the printing press, the internal combustion engine, and the semiconductor are all such examples. That being said, we continue to reiterate our position that not owning Cisco is analogous to not owning the railroad stocks in the 19th century.
Finally, when looking at the numbers relative to the size of future growth for Cisco, consider that the convergence of voice, video, and data is a $350 billion opportunity over the next five years. Based on the current Cisco product portfolio, they have a $140 billion opportunity. If one takes a conservative approach and gives Cisco a 20% share of this business, it is a $28 billion opportunity. If one expects Cisco to remain a dominant player that will garner a 40% share of the business, that equates to a $56 billion opportunity. The reality probably lies somewhere in between, which could translate into Cisco tripling or increasing sevenfold over the next five years.
TRADING UPDATE: Last week we shorted the Cisco Feb 105 puts at 2 9/16, and took in $2562 for every 10 contracts we shorted. We used the premium to continue building our cash position in anticipation of a 10-20% pullback, creating an excellent intermediate term buying opportunity. Given the decline in the stock, we were premature in executing this trade, and the objective became to reduce the risk of getting assigned more of the stock, which would have resulted in being about 105% invested. Thus, we capitalized on the increase in implied volatility, and covered our Feb 105 puts at 6 3/4, and shorted the March 105 puts at 9 1/4.
For those not familiar with this strategy, you are buying yourself time to be right, and in addition taking in even more premium. In this particular trade, we kept the original $2562 for every ten contracts we shorted, and took in an additional $2500 for every ten contracts shorted.
Also, we took profits on Jan 27 on our MSFT Jan 2001 150 calls, which proved to be a prescient call. We bought them on Jan 5-6 at an average cost of 35.3, and sold them at 53, generating a 50% return in about three weeks. We anticipate the stock resuming its advance soon in anticipation of the split, but would look to be very nimble traders of the 150 Leaps calls. It is becoming obvious that MSFT is going to lose the first round versus the DOJ, and this should create short term weakness in the stock after the split. We are still looking for new subscribers, and welcome all current subscribers to pass The High Tech Arena on to friends and associates.
DISCLAIMER: The information herein has been obtained from sources which are believed to be reliable, but there are no guarantees as to its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.
THE HIGH TECH ARENA
Joe Arena Editor
JRArena@aol.com
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