Can Cisco keep up its torrid pace?
After another strong quarter, observers say there is no end in sight for internetwork firm's growth.
By JIM DUFFY
Network World, 02/15/99
SAN JOSE - On the heels of another stellar quarter, Cisco users and analysts see little that can slow the network equipment company down.
Enterprise sales may be slowing and pricing pressure may be increasing, but the company is more than making up for it with strong sales to carriers and ISPs. Meanwhile, Cisco is facing down tough rivals, such as Lucent and Nortel Networks, by ramping up new ATM WAN switching products along with offerings that bridge circuit switching and packet switching nets.
In addition, the company is aiming to keep its technical edge by directing increasingly larger chunks of its revenue toward research and development: some $1 billion during Cisco's fiscal year 1998.
Cisco posted revenue for the second quarter, ended Jan. 23, of $2.83 billion, up 40% from the corresponding quarter last year. Earnings jumped to $606 million, up 33% from second-quarter 1998 earnings of $457 million.
According to financial analysis firm Warburg Dillon Read (WDR), the 40% revenue growth represents Cisco's fourth consecutive quarter of increasing year-over-year growth and is the first quarter of 40% year-over-year growth since the third quarter of 1997.
Cisco's competitors are experiencing mixed results, with Nortel and 3Com posting respectable numbers in their most recent quarters, while Cabletron has disappointed financially.
Cisco owes a lot of its second-quarter success to the service provider market, in which carriers and ISPs are bulking up on data network gear to quench customers' thirst for Internet access and to supplant traditional circuit-switched voice infrastructures. Sales of Cisco routers and WAN switches to service providers increased more than 50% from the second quarter of last year, according to WDR. Sales in this market account for 25% to 30% of Cisco's total revenue, WDR estimates.
Enterprise sales, on the other hand, are growing 30% year over year, with the small and mid-size enterprise market growing in the 30% to 50% range. But the entire enterprise market is susceptible to price erosion, analysts say.
Nonetheless, with 40% revenue growth from a year ago, Cisco's second-quarter results are remarkable. And Cisco rolled out 13 products in the second quarter, setting the stage for future revenue growth. These products included the Catalyst 2948G, 4000 and 6000 LAN switching lines; voice and IP telephony support for the Catalyst 5000 line; and Cisco's first products for the consumer market.
But can the firm keep up its torrid pace? Analysts say, "Yes."
"Right now, if you look at Cisco's position in the marketplace, it's never been in as good a position across the board," says Scott Heritage, an analyst at WDR (see chart, page 19).
The momentum will continue despite Cisco's foray into the service provider and voice network worlds, where the company will run into bigger, more entrenched competitors, such as Lucent and Nortel. Even Lucent's $20 billion acquisition of carrier data network giant and Cisco rival Ascend Communications won't slow Cisco down, the analysts say.
"They're addressing a huge new market opportunity with entrenched competitors that are tied to old technology," says William Becklean, an analyst with Tucker Anthony in Boston. "They can keep up the pace for at least the three-year horizon that I'm looking at."
Warning signs
Cisco is nonetheless wary. "Both Lucent and Ascend are well-run companies, and we view them as formidable competitors," Cisco's Executive Vice President Don Listwin told financial analysts during a conference call earlier this month. "But we continue to believe that most major acquisitions will fail."
Listwin notes substantial gaps in Lucent and Ascend cultures, visions, geographic proximity and the inevitable departure of senior managers and engineers.
"That said, we are assuming it will be successful and are positioning ourselves to compete appropriately," Listwin says. Analysts expect Cisco to enhance its ATM WAN switching portfolio to give Ascend's Cascade switches a run for their money.
The main obstacle in Cisco's path could be the global economy. If economies around the world turn gloomy, that will affect enterprise and service provider spending, which would stunt Cisco's - and any company's - growth.
Indeed, the global economy was mentioned by Cisco CEO John Chambers during the conference call as one of four areas of concern for the firm. The others are competition and consolidation, Year 2000 issues and government regulation.
Despite the warnings, enterprise users see little to stem Cisco's momentum. But they do point out potential pitfalls. Cisco's practice of forcing hardware upgrades on enterprise users every three years won't wash in the service provider realm, says James Wiedel, director of networking in the computer services department at the University of Southern California in Los Angeles.
"They're making this great push into telephone land. What telephone company is going to throw away their hardware every three years?" Wiedel asks. "You'd have to be crazy. That's an insane investment from a telephone company perspective."
Cisco's growth might be pinched by the inability of service providers to turn up new services in a timely fashion, says Joe Askins, data communications director at Arizona State University in Tempe.
"We don't see a good solution for telecommuting right now other than a dial-up modem, which is not really telecommuting," Askins says. "So how is this stuff really going to take off if the [regional Bell operating companies] and [competitive local exchange carriers] can't do that last mile?"
Askins says slowing sales in the enterprise market and potential snags in voice-over-data reliability may also upset Cisco's momentum.
Stephen Koffler, an analyst at Donaldson Lufkin & Jenrette, agrees that Cisco may feel the fall-off in enterprise purchasing.
"The one factor most likely to impact them is overall enterprise slowdown in spending in the fourth calendar quarter as companies look to maintain a frozen hardware environment going into 2000," Koffler says. He adds Cisco will continue to produce "really solid results" for the next two years.
Voice will also be a challenge for Cisco going forward, but a challenge the company will easily sidestep, says Paul Johnson, an analyst at BancBoston Robertson Stephens.
"They will never be successful at voice, and yet IP is so powerful that they will continue to grow at an amazing rate and surprise people," Johnson says. "IP is going to be much bigger than people realize. It won't matter." Cisco's Listwin said during the conference call that the company booked more voice ports in the second quarter than in all of fiscal 1998.
Cisco will face a greater challenge from start-ups developing high-speed routers and switches for service providers, Johnson claims. "There are lots of start-ups, and start-ups can be successful in niches and niches can get big," he says. "That's how Cisco was formed 15 years ago."
The rest is history, as they say, and observers see no end in sight.
"It's very hard to find anything negative to say about Cisco, its strategy, its opportunities," says Andy Schopick, analyst at investment firm Nutmeg Securities. "This company's in the driver's seat."
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