At the end of 2008 - still in the shadow of the worst recession in decades - Cisco (Nasdaq:CSCO) shares were trading around $16, and the company had just posted trailing 12-month per-share earnings of $1.33. Now fast forward to today. The stock's currently trading near $15, and the company has earned $1.27 per share over the past 12 months.
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Not that the recovery has been easy for anybody, but Cisco just skipped it altogether.
Bad luck, or bad company? The bad news is, it's more the latter than the former. The good news is, the patient doesn't have to be terminal. To know how to fix Cisco though, you have to know what's wrong with it. Here are the two biggest problems, which are also closely related.
Lack of Competitive Pricing
In the late 90s, as broadband internet connections were proliferating, Cisco was the go-to name in routers. That's not to say it was the only company making them then; Realtek, Linksys (a Cisco company), and Netgear (Nasdaq:NTGR) were around. But, considering Cisco was the second-largest U.S. company (by market cap) in late 2000 as the stock fearlessly traded up to a P/E ratio of more than 200, one thing was clear ... investors were confident the company would continue to dominate the high-end corporate and government networking market and be able to charge an amazing premium for its wares.
Of course in retrospect we all know things changed shortly after, and by the time the world was coming out of the 2000 to 2002 recession, technology consumers had more choice - and more price selection - in networking gear. Unfortunately, Cisco held onto the "premium" pricing model too long, and it still struggles with that mindset.
In fact, in May's Q3 conference call, CEO John Chambers specifically noted that customers were opting for lower price-point equipment. Government sales, which were at one point a huge segment of Cisco's target market, have actually fallen by 8% this fiscal year versus prior growth rates of 30%.
That's not to say the premium pricing strategy has been a total failure; Cisco has indeed managed to grow its bottom line since 2003. But, it's been a begrudged effort. And considering per-share profits have started to fall again over the past four quarters, clearly there's something flawed with the pricing strategy. The fact that its competition hasn't faced the same struggle verifies it.
In 2007, Cisco controlled an estimated 72% of the internet switching market; now it controls 67%. Though not a huge loss in market share, the number of competitors chipping away at that share is growing in number. Juniper Networks (NYSE:JNPR) has been nipping at Cisco's heels since it shipped its first router in 1998 and Brocade Communications (Nasdaq:BRCD) is also in the mix. In the meantime, Hewlett-Packard (NYSE:HPQ) has started to make waves in the networking world.
It's the edge router market where Cisco is really feeling the pain though. In 2005, Cisco owned 58% of this business. In Q4 of last year, Cisco only controlled 37% of this segment of the router world... and the number is still shrinking.
The million dollar question, of course, is why? The first reason is the obvious one: price. Technology buyers are very price sensitive now.
The other reason is a more technically-oriented one, but may well be the biggest reason of all Cisco is hitting a wall.
According to Juniper CEO Kevin Johnson, Cisco's hardware doesn't integrate well even with other Cisco hardware ... the result of multiple acquisitions of technology companies, each of which wrote their own software to operate their own hardware. As such, managing Cisco-powered systems is logistically challenging. Johnson attributes a great deal of Juniper's market penetration to the fact that all of its hardware runs on a single operating system, making integration and intra-gration easier.
The Bottom Line
To some degree Cisco has already acknowledged its price-point issues, and is looking to be more competitive in that front. Yet, the market still views much of its hardware as overpriced and is seeking cheaper alternatives. This liability can be fixed, but will it?
As for doing away with multiple operating systems, that's a tall order that may only be fixable by a phase-out rather than an overhaul. Either way, it makes the Cisco growth hurdle higher.
But until the company fixes both, "more of the same" should come as no surprise. (For related reading, also take a look at Brocade Moves Two Steps Forward, One And A Half Back.)
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