Cisco Slips in ATM Switch Market
By Kevin Petrie
Staff Reporter
5/7/99 1:28 PM ET
SAN FRANCISCO -- Uncharacteristically, Cisco
(CSCO:Nasdaq) doesn't seem to have the answer to the
growth of a pivotal network technology.
Cisco has failed to develop a new "asynchronous transfer mode"
switch, which telephone carriers are installing on their networks
to direct long boxcars of Internet traffic. ATM switches are more
dependable than the "Internet protocol" systems Cisco is
promoting, and so far seem the best way to combine voice and
data signals. Researcher Dell'Oro Group says ATM sales grew
49% to $3 billion last year.
Now Cisco, which is expected next week to report strong
third-quarter earnings and revenue growth, finds itself lagging
further behind competitors Nortel (NT:NYSE) and Ascend
(ASND:Nasdaq) (set to merge with Lucent (LU:NYSE) by late
June). The divergence threatens to erode Cisco's market share in
the carrier ATM business, which according to Dell'Oro fell to
19% in the fourth quarter from 23% in the first quarter of 1998.
In the same period Nortel's and Ascend's market shares
expanded to 25% from 18% and to 23% from 18%, respectively.
So Cisco is in a bind, and its usual crisis tactics might not do
their magic this time. Typically the San Jose, Calif.-based
company responds to market shifts by acquiring technology or
applies the marketing charm to its Fortune 1,000 clients. Those
maneuvers, coupled with superb managerial skills, explain how
Cisco's sales have swelled to $10 billion over the last four
quarters and its market cap has ballooned to $174 billion since
the company booked its first sale in 1986.
This crisis is different. Cisco's new target clientele, carriers such
as AT&T (T:NYSE) and Sprint (FON:NYSE), boasts closer ties
to the competition. And there are few ATM companies available
for Cisco to acquire.
Cisco has canceled development of an ATM switch called the
TGX 8750, widely viewed as a crucial product for competing with
Nortel and Ascend. Instead, it intends to incorporate TGX
features, including wide optical-fiber connections, into an older
8850 product line and re-release it early next year.
Cisco won't say when it made the decision. The company
discreetly noted the product change on its Web site in early April,
but didn't make executives available to discuss the move, which
was reported Monday by the trade publication Network World.
The stock has slipped mildly this week along with the Nasdaq, to
106 15/16 Thursday from 114 1/16 last Friday. Cisco is down
nearly 10% from a 52-week high of 118 3/4 on April 7; it now
trades at 130 times trailing four-quarter earnings.
Next Tuesday Cisco is expected to announce a 23% increase in
operating profits for the fiscal third quarter ended in April, and
should even report growth in its business with carriers. Equity
analysts are standing pat with their buy recommendations and
their bullish estimates. But Cisco's failure to deliver such an
important product raises unfamiliar doubts as the pros study
their favorite stock.
"It shouldn't just be brushed under the carpet," says one analyst,
who rates the stock a buy and did not want to be identified. His
firm has no banking ties to Cisco. A year from now, "if you don't
have a product and you're not there soon enough, you can't win
the business."
In the past, Cisco has successfully adjusted to shifts in customer
tastes. In 1993, Cisco spent $90 million stock buying
Crescendo, a 60-employee start-up in Sunnyvale, Calif.,
branching from network routers into the emerging switch
business and juicing its revenue growth for several years.
As it grew more powerful, Cisco used marketing to cover up bad
moves: It promoted the need for "universal standards" to buy a
year and a half of time to integrate the ill-fitting technology of
Granite Systems into its product line. The marketing spin was
"classic Cisco," says analyst Craig Johnson with the Pita Group
consulting firm, who owns Cisco shares.
This time Cisco is in a tighter spot. For one thing, marketing is
more challenging, because it is trying to court business with
carriers which know Nortel and Lucent much better than they
know Cisco. And while Cisco struggles with ATM, Nortel and
Ascend already deliver strong ATM offerings.
So winning significant contracts remains difficult. A month ago,
Cisco announced plans to furnish AT&T with so-called IP+ATM
switches; however, AT&T says it still primarily uses ATM
equipment from Ascend. AT&T expects to grow IP traffic in
coming years, but for now still needs Ascend ATM gear.
"They're walking into places where they are not the established
vendor," says one industry analyst who has worked for a Cisco
rival. "They are seeing competition like they haven't seen before."
Cisco has delayed other ATM products. Several analysts say the
company was six months late in furnishing Sprint with a switch
from its 8800 product line for Sprint's ION network, designed to
meld voice and data traffic. Sprint confirms this, although an
official says it fully expected the delay and is proceeding with
construction as planned. Sprint activated certain ION services
early this year and has signed 12 corporations in 26 cities for the
service. Cisco says that, despite certain shifts in timing, it
delivered the equipment on schedule.
"The problem they have right now is credibility in the product
road map," says Rosemary Cochran, principal with Vertical
Systems Group, a market researcher in Dedham, Mass.
Cisco also faces greater challenges this time because there are
fewer acquisition candidates to fill its ATM hole. Ascend gobbled
ATM concern Cascade in mid-1997. Last week, Fore Systems
(FORE:Nasdaq), a prime ATM supplier, agreed to merge with
GEC of Britain for $4.5 billion in cash.
While ATM company Newbridge Networks (NN:NYSE) of
Kanata, Ontario, remains independent, it has had trouble
executing. Newbridge, with revenue of $1.7 billion and a market
value of $5.2 billion, is much larger than any company Cisco has
ever acquired. The private start-ups Netcore and Nexabit are
testing routers that handle ATM, but remain focused on Internet
protocol. Cisco defines itself as an IP leader.
"It would be very hard for Cisco to admit they have to buy an IP
company," says the industry analyst.
The TGX snafu all started with an acquisition gone bad. Three
years ago, Cisco bought StrataCom, a builder of ATM switches,
for $4 billion in stock. Cisco has done little to upgrade
StrataCom's BPX switches since then. The TGX was supposed
to restore StrataCom's worth.
Speaking in his offices Monday -- before Cisco stopped
answering TSC's inquiries about the TGX -- a marketing vice
president, Larry Lang, said he was surprised that carriers and
ISPs still counted for only one-third of Cisco's revenue. He says
that is because corporations, historically Cisco's strength, have
continued to generate strong sales.
Given Cisco's frustrations with carriers, that route might be the
company's best hope for keeping its 30% growth intact.
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