Analyst Commentary

Cisco will return to revenue growth in 2H14 by managing product transitions in its core business and investing in high-growth segments like cloud

Below is TBR’s commentary on Cisco’s CY1Q14 (FY3Q14) financial results. Please feel free to use this content with TBR and analyst attributions. Contact Scott Dennehy at (603) 929-1166 or for additional commentary.

Weak customer demand for switching and routing products in emerging markets remains a drag on Cisco’s revenue

Cisco’s total revenue declined year-to-year for the second straight quarter in 2Q14, a 5.5% decrease driven by declines in the company’s three largest product segments: Switching (down 6%), NGN Routing (down 11.9%) and Service Provider Video (down 26%).

However, TBR believes Cisco’s 2Q14 financial performance indicates the worst of the company’s revenue declines may be behind it. The 5.5% decrease in 1Q14 was an improvement over 4Q13 (down 7.8%). After declining 4% year-to-year last quarter, product orders in 1Q14 were flat, with growth in major markets such as the U.S, U.K. and northern Europe. However, demand in emerging markets remains sluggish, particularly Brazil and Russia, due to concerns over the economy and product transitions in the service provider market that are resulting in lower order volume for high-end routing platforms.

TBR expects Cisco’s total revenue to decline year-to-year in the low single digits in 2Q14, a smaller decline than 1Q14 as revenue in Switching and NGN Routing improves due to increased customer adoption of recently released high-end switching and routing platforms such as the CRS-X, NCS and Nexus 9000.

Cisco’s major cloud strategy shift advances its development into an IT solutions provider

Cisco announced at its annual Partner Summit in March that it will invest $1 billion in its cloud business over the next two years — with a portion of the investment going toward the build of global data centers to sell cloud services to its partners and service provider customers. The move is a significant departure from the company’s previous strategy of being just a cloud “arms dealer” (i.e., providing the infrastructure elements to service providers and enterprises that enable public and private clouds).

TBR believes the new cloud strategy will negatively impact Cisco’s hardware sales, particularly in the service provider segment, as customers will be able to leverage Cisco’s application-centric, network-aware services without buying routing and switching infrastructure for their cloud environments. However, the move is necessary to help the company evolve into a services-focused IT solutions provider, as cloud continues to upend the traditional hardware model — even for a dominant market leader such as Cisco.

In addition to delivering its applications, including collaboration, desktop virtualization and security, Cisco will support applications from a variety of partners including SAP, Microsoft, VMware and Citrix. But the move will place Cisco into competition with other key partners, such as IBM, as well as customers like Verizon that sell public cloud services using their own infrastructure. However, Cisco anticipates the benefits of targeting this market outweigh the risks, just as it did entering the server market in 2009 and effectively ending its long-standing partnership with HP.

TBR believes Cisco will face challenges executing its new cloud strategy, as the focus on applications and services does not play to the company’s core strengths in hardware. However, Cisco will invest in additional partnerships and tuck-in acquisitions to quickly establish itself as a key player in the next phase of the cloud services market.

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