Hi, I found this on the "Fool's thread" and thought you might be interested in reading it...Too bad I didn't have this Q & A just a few days ago, huh????
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FOOL'S DEN
The Cisco Kid
A Q&A on Cisco Systems With Phil Weiss
With Phil Weiss (TMF Grape)
March 7, 2000
Most people have heard of networking giant Cisco Systems (Nasdaq: CSCO). You probably even know it has something to do with the Internet. But how many of you actually know what a router is? A switch? A switch router? Fool Analyst Phil Weiss does! Here he tackles some of the frequently asked questions about the company.
Q: For starters, what the heck does Cisco actually do?
A: What Cisco sells the most of is routers and switches. Of course, if you're like me, you've never seen one of those up close, so that probably doesn't help much. So, I'll try again. The routers and switches Cisco sells help control and manage the movement of data from network to network and user to user. What its products really do is help make the Internet work. It's a picks-and-shovels kind of company, which means that its products support the underlying infrastructure of the Internet.
The hardware and software solutions sold by Cisco link computer networks and give people easy access to information without worrying about where they are, when they're there, or what type of computer they're using. Cisco's strategy is to provide end-to-end networking solutions to help its customers improve productivity and gain a competitive advantage in today's global economy.
Q: One thing you hear around the Fool quite a bit is that investors should "buy what they know." Does that mean only techies can invest in Cisco?
A: Absolutely not. I'm a CPA by trade and not a techie. When I worked in public accounting I did once run a network, but they were a lot less sophisticated then than they are now. My personal take on this is that you can buy anything that you want as long as you're willing to put in the time to learn about it and follow it over the years. There's a lot of available material that you can read to help better understand Cisco's business, so if you're willing to invest the time, you can get enough of an understanding to invest in the company. This was actually one of the things I focused on in my research report [which will be available on March 10]. I went to great lengths to describe the networking industry and the kinds of products that Cisco sells.
Q: Cisco has grown tremendously over the past decade. Can it really expect to sustain this level of growth?
A: Can it continue to grow its sales by the 77% annual rate it has since going public? No. Can it continue to grow sales at the 30-50% rate that it has over the last several years? Yes. In a recent PC Week interview, Cisco's CEO, John Chambers, said that he expects Cisco to sell $50 billion worth of products by 2004. Since it only sold $15 billion of products in the last 12 months, that's a pretty heady goal. But I certainly wouldn't count Cisco out. It has one of the best track records for meeting or exceeding its targets of any company that you'll find in the market today. You might even say that Cisco is more paranoid than Intel's Andy Grove. As always, one of the primary keys to Cisco's success will be its ability to execute.
Q: What about acquisitions? Cisco is currently planning to make another 20 or more acquisitions over the next year. What is the strategy behind this? And how is Cisco financing all these purchases?
A: Cisco has a SWAT team of people responsible for integrating the operations of the companies that it acquires into its own operations. It assimilates companies into its operations in a way that's similar to the Borg on Star Trek. You could easily say that Cisco has written the book on how to pull off successful acquisitions.
While approximately two-thirds of Cisco's revenues relate to products that it has developed rather than those it has acquired, acquisitions are an important part of Cisco's strategy. The company puts forth a tremendous amount of effort to make these acquisitions work. Since many of Cisco's acquisitions are start-up or early-stage companies, one of the main things that it is looking to acquire is people, not products. As a matter of fact, one of every five or six Cisco employees has her roots with a company acquired by Cisco.
The majority of Cisco's acquisitions are funded with its highly valuable stock. However, there are times that cash or a combination of stock and cash is used. The way in which the purchase is funded depends on the objectives of Cisco and the target company and is impacted by such issues as the tax treatment of the transaction and liquidity. The exact way in which acquisitions are funded is part of the negotiating process.
Q: How do all these acquisitions affect Cisco's valuation?
A: There are a few issues here. One is that when Cisco uses its stock to fund an acquisition, there's some dilution of stock ownership, which results in lower earnings per share and cash flow per share. Another is that Cisco is richly valued enough on its own that on many occasions the company it acquires actually trades at lower multiples than Cisco. Also, a number of Cisco's acquisitions have made significant contributions to its explosive growth; e.g., in 1993 Cisco bought Crescendo Communications for $95 million in stock. Today, Crescendo's switches as well as products from some of the acquisitions that followed form the core of a unit that now generates $7 billion in annual sales. Most important, Crescendo's four founders still work for Cisco.
Q: What's the story with the pro forma results that Cisco gives every time it releases earnings?
A: Cisco's acquisitions often lead to such charges as acquired in-process research and development and amortizable goodwill. These non-cash charges are not part of Cisco's regular operations, and even though it's made 51 acquisitions, Cisco is not in the business of acquiring companies. By excluding these charges and expenses from earnings, an investor is better able to compare and analyze results from Cisco's business operations.
Q: Does Cisco have a venture capital fund like Amazon? If so, might it be more beneficial for the company to invest in smaller companies rather than just buy them outright?
A: Cisco often makes investments in companies that it eventually acquires. For example, it owned 9% of Cerent before purchasing the balance of the business this past fall, and it already owned 9.5% of a company it acquired last week, Atlantech Technologies. These investments are used by Cisco as a strategic tool. They allow Cisco to look more closely at potential acquisitions.
However, Cisco's business is much different than Amazon's. It aims to provide end-to-end networking solutions to its customers. By acquiring companies outright, Cisco is better able to integrate the acquired products into its own operations. Plus, Cisco runs its business so efficiently that in the long run it will be most successful by bringing the whole operation in-house.
Q: How much will Cisco benefit from business to business (B2B) e-commerce both directly and indirectly? As a supplier, it sells directly off of its website. Will it participate in B2B exchanges (a virtual marketplace where buyers and sellers come together to transact business)? How will Cisco benefit from the infrastructure required for B2B?
A: There are several ways in which Cisco will benefit from the growth of B2B. It can provide the hardware needed to get suppliers connected to high-speed, reliable, and secure networks. As an example, Cisco recently took an equity stake in Ford's AutoXchange System. Its involvement in this exchange helps address a major problem of any supplier exchange: getting suppliers connected to the exchange so that they can fully utilize all its functions. Cisco can also provide its expertise in supply-chain management. It has saved hundreds of millions of dollars in operating costs by transferring a number of business functions to Internet-based applications.
As far as Cisco's own participation in B2B exchanges goes, I'm not aware of any so far. However, Cisco has a history of changing to fit its environment -- Chambers said recently that Cisco has literally changed the company seven times over the last decade -- so I'm sure that it will become a participant if that becomes necessary in the future.
Q: Cisco has said it plans to market its products to consumers in the near future, but the company's product lines aren't exactly geared toward the average home computer user. How will Cisco be able to adapt its current offerings for the consumer market?
A: If you're not a technophobe, the possibilities here are actually quite exciting. For starters, the significant decline in personal computer costs is leading to an increase in the number of multiple-computer households. The cost savings that come from sharing communication lines and devices such as printers will most likely lead to an increased demand for home-networking products. Home networking is expected to be a multibillion-dollar business over the next four to five years. Wireless will be another key consumer initiative.
What's even more intriguing is something called the Internet Home, which is a partnership between Cisco and the construction company Laing Homes. Some examples of what it aims to make possible are switching on your heating system while you're still in your office, seeing who is at the door without getting off the couch, and surfing the Web via your television. You'll even be able to talk to your home via the Internet when you're away on vacation. Cisco is also part of a partnership that includes Whirlpool. It is expected that an Internet-ready refrigerator will be introduced by the end of the year.
Q: What is it that allows Cisco to trade at a premium multiple to large competitors like Lucent Technologies and Nortel Networks?
A: Start with the fact that Cisco is a New World company with its roots in data and the adoption of a single integrated architecture for voice, video, and data. This has helped Cisco to gain a sustainable competitive advantage, and has made the company much more agile and adaptable to change than its competitors. Many companies are now asking Cisco to help them implement the right Internet architecture and Internet applications in their businesses, so that they, too, can achieve the level of productivity increases, cost reductions, and competitive advantage needed to survive and succeed in the Internet economy. In addition, based on the criteria discussed in Step 6 of the 11 Steps to Rule Maker investing, Cisco has the highest quality financial statements of any company in its industry.
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