Here's Why the Best Is Yet to Come for Cisco Systems
If you're a Cisco (NASDAQ: CSCO) investor like myself, you're probably unimpressed with the company's anemic 3% growth this year. Its core business of routers and switches remains stagnant, and its higher-growth businesses are still too small to offset that slowdown.
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Despite those challenges, I believe that its valuation and dividend Opens a New Window. make it a fairly safe play for today's frothy market. Today, I'll examine Cisco's biggest opportunities to see why its best days could still be ahead.
Repatriating its cash
Cisco finished last quarter with $68 billion in cash and equivalents, but 96% of that total remains overseas. Like many other multinational companies, Cisco won't repatriate that cash to the United States because it would be hit with a 35% corporate tax.
However, the Trump Administration has proposed a one-time 10% tax on all repatriated cash. House Republicans want an even lower rate of 8.75% on foreign earnings held as cash, and a 3.5% tax on all other foreign earnings. If either of these proposals pass, Cisco could bring the lion's share of its revenue back home for domestic acquisitions, buybacks, and dividends.
That's why Credit Suisse gave Cisco a rare "double upgrade" from underperform to outperform in late April -- noting that smart moves with that cash would accelerate its "transition toward a diversified IT player."
Becoming a cybersecurity powerhouse
Cisco bundles its higher-growth software services with its routers, switches, and unified computing systems. Its highest growth business is its cybersecurity unit, which posted 12% annual sales growth during the first nine months of the year and accounted for 4% of its top line.
That seems like a modest percentage, but Cisco has been expanding that business by buying smaller cybersecurity companies like Sourcefire, ThreatGRID, and CloudLock. With a free cash flow of $12.7 billion over the past 12 months, Cisco has plenty of room to bolster that business with additional acquisitions. If it repatriates its overseas cash, it could swallow up even bigger players.
500 billion connected devices
Cisco estimates that the number of connected devices will surge from 25 billion in 2015 to 50 billion in 2020, and 500 billion by 2030. As one of the world's largest networking hardware companies, Cisco should profit from those increased connections across the Internet of Things (IoT).
To prepare for that growth, Cisco added analytics capabilities into its networking hardware, partnered with automakers to provide in-vehicle network tech for high-speed transfers, and helped cloud companies link their platforms to IoT gadgets. It also acquired Jasper Technologies -- now known as its IoT Cloud Business Unit -- last year. That growth should cast a halo effect across all of its hardware and software businesses.
Staying ahead of Arista
In a previous article Opens a New Window. , I noted that one of the biggest threats to Cisco was the rise of "white box" generic routers and switches that run on open source software. These SDN (software-defined networking) solutions run on lower-power hardware, with the heavy lifting done by cloud-based software.
Cisco's biggest challenger in the SDN market is Arista Networks (NYSE: ANET), which sells cheaper multilayer network switches specifically designed for SDN uses. Arista also claims that using its FlexRoute software with those switches will eventually render traditional routers obsolete.
Cisco repeatedly sued Arista over patent issues to keep it away from its key markets. Cisco scored a key victory in early July when federal regulators ordered Arista to stop importing its products into the U.S. on grounds that they infringed on Cisco's patents.
Arista is appealing the ruling, so the ban might be temporary. But it gives Cisco valuable time to promote its own SDN solutions. Selling cheaper SDN hardware could dent Cisco's margins, but it would widen its moat against Arista and enable it to bundle additional services with its hardware.
The road ahead
Cisco's future looks murky, but a few major moves could get the company's growth back on track. A green light for repatriation would help the stock break out of its rut, while subsequent acquisitions, buybacks, and dividends could make Cisco an exciting investment again.
In the meantime, I'll hold on to my Cisco shares, since the growth of its cybersecurity unit, its victory over Arista, its solid dividend, and low valuations all make it a good defensive play -- with or without access to its overseas cash.
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