Ticker:
CSCO
Sector:
Technology
Industry:
Communications
Equipment
Recommendation:
DON’T BUY
Pricing
Overview:
Closing Price
$26.60 (4/9/10)
52-wk High
$26.85 (4/9/10)
52-wk Low
$17.13 (4/9/10)
Market Data
Market Cap
$152.07B
Total assets
$68.128B
Valuation
EPS (ttm)
$1.04
P/E (ttm)
25.58
Profitability & Effectiveness (ttm)
ROA
9.7%
ROE
16.8%
Profit Margin
17.0%
Oper. Margin
25.3%
Analyst:
Jeff Griffith
jmgxb6@mail.missouri.edu
Cisco Systems Inc, currently the largest company in the
Communications Equipment industry, offers a variety of
communications products and services. The company supplies most
of the Internet Protocol (IP) networking equipment used for the
Internet and is the world’s largest supplier of high-performance
computer internetworking systems. The company offers products in
four segments: switches, routers, advanced technologies, and other.
As of the end of Cisco’s fiscal year in July 2009, switches made up
41% of sales. Cisco has become the dominant market leader in
Ethernet switches with 70% market share. Cisco also leads the
market in overall routing, with more than 50% market share. For core
high speed routers (more than 2.5 GB/sec), Cisco and Juniper
Networks together have a combined market share of more than 95%.
The advanced technology segment is currently composed of seven
segments: home networking, unified communications, security,
storage area networking, wireless technology, application networking
services, and video systems. According to the S&P report from March
20, 2010, this segment will be the primary driver of company sales
growth. The company also offers a broad range of services, including
technical support and advanced services. Cisco’s recent major
acquisitions activity includes: October 2009, Cisco agreed to acquire
Tandberg (a Norway-based communication solution provider) and
Starent Networks (a mobile system provider), each for $3 billion in
cash. Both are expected to close in the first half of 2010, subject to
necessary approvals.
Recommendation: After spending a lot of time carefully analyzing
this company, I recommend that the we DON’T BUY stock in CSCO.
There are many attractive aspects of Cisco. The company does have a long operating history since it was
founded in California in 1984. Cisco also has strong financials, including $40 billion of cash and
investments. According to the S&P report, Cisco has one of the best financial profiles in the industry. The
company is currently well positioned in the market. Cisco’s enormous budget for R&D of $5.2 billion
promises continued innovative products. This industry also has a promising future. The Portfolio
Committee determined the Communications Equipment industry to be an attractive growth opportunity
because as the economy improves it is likely that companies will spend more on increasing their
bandwidth.
Despite all of the attractive aspects discussed above, we should not buy stock in Cisco because it is
significantly overvalued, does not pay a dividend, and there is currently a trend to shift toward
technology convergence. As this happens, HP, the largest technology company in the world, will likely
steal market share from Cisco. Also, as convergence continues, our portfolio will have more exposure to
this industry through HP because we currently hold a significant position in HP in our portfolio.
Using conservative growth rates for Cisco, an intrinsic value per share of $11.90 was calculated using
Warren Buffet’s Discounted Cash Flow model. This indicates that the company is signifcantly overvalued
because its stock currently trades at more than twice that value. The are some people that think this
company is undervalued. The S&P analysts calculated a value of $30.00 per share, indicating it is
undervalued. I made some adjustments to my model to figure out what they did to get that value. I
believe those analysts did not make adjustments for the average increase in working capital as well as
for average capital expenditures. In order for my model to value CSCO at $30, I had to remove both of
those adjustments. It is important that we do make adjustments for both of these because they do
affect the earnings available for shareholders. I think that while Cisco appears to be a good company, at
this time it would not be a good addition to our portfolio.
Major Characteristics:
Cisco is by far the largest company in the Communications Equipment industry.
Cisco is the 57th largest company on the Fortune 500 Ranking.
Cisco is the dominant market leader in enterprise routers with almost 69% market share.
Cisco is also the dominant market leader in Ethernet Switches with about 67% market share.
SWOT Analysis
Strengths: Relative to its competitors, Cisco has a broad portfolio of different operating
segments allowing fairly diversified earnings. Approximately 46% of Cisco’s net revenues come
from international markets, and the company continues to expand into emerging markets. HP is
a leader or among the leaders in each of their business segments. With Cisco’s current
acquisitions in process of Tandberg and Starent Networks, Cisco will be able to offer better
video and mobility for its communication network. Also, as stated earlier in this report, Cisco
has one of the best financial profiles in the industry. The company also has dominant market
share in the large routing and switching sectors and successful positioning in several advanced
technology areas.
Weakness: Because of Cisco’s diversified earnings, it is less specialized in its different operating
segments. To keep its competitive position, Cisco offers many innovative products which results
in high R&D costs that must be expensed when they occur. The demand for Cisco’s products is
very difficult to forecast which often leads to surpluses or shortages of its products. Also, from
an investor standpoint, Cisco may not as attractive of an investment because it does not ever
pay a dividend.
Opportunities: Cisco’s high R&D budget, which is used to create many diverse and innovative
products, allows the company the ability to find many opportunities with the creation of new
products. Cisco continues to expand into emerging markets which will bring in future revenues.
The demand for technology will continue to grow because the world is becoming increasingly
more connected. As the condition of the economy improves, it is expected that many
companies will seek to increase their bandwidth, which can be done using products that Cisco
offers.
Threats: Cisco’s financial performance is largely dependent on the market conditions. If we are
to see a second dip in the market, the company will likely be greatly affected by it. Also, if as
the economy improves, there is a slower-than-expected recovery in enterprise or telecom
spending, this will also greatly affect Cisco’s performance. Also, if Cisco is to meet increased
competition or to see pricing measures intensify, this would have a great affect on its
performance as well. Like many IT industries, the Communications Equipment industry is
currently undergoing a shift toward technology convergence which results in the market
segments become more intertwined and Cisco finding itself in more competition with the larger
IT companies, such HP and IBM.
Competitors: Cisco is a large company with many different business segments and the list of
competitors is enormous. Although there is a large difference in company size, Juniper Networks is the
company that has products that are most similar to Cisco’s. Cisco’s competitor that most closely mirrors
its size and operations is probably Hewlett Packard (HPQ).
DIRECT COMPETITOR COMPARISON
CSCO
HPQ
JNPR
Industry
Market Cap:
147.89B 124.85B
Employees:
65,550 304,000
7,231
786
Qtrly Rev Growth
(yoy):
8.00%
1.90%
33.40%
Revenue (ttm):
8.20%
35.53B 116.92B
15.87B 351.31M
3.32B 167.54M
Gross Margin (ttm): 64.47% 23.44% 65.08%
EBITDA (ttm):
9.42B 16.22B 660.86M
42.68%
4.17M
Oper Margins (ttm): 21.41%
9.84%
15.46%
2.87%
Net Income (ttm):
6.07B
8.05B 117.00M
N/A
EPS (ttm):
1.039
3.317
0.219
N/A
P/E (ttm):
24.86
16.05
139.04
50.11
PEG (5 yr expected):
1.38
0.89
1.45
1.53
P/S (ttm):
4.19
1.07
4.82
2.27
HPQ = Hewlett-Packard Company
JNPR = Juniper Networks, Inc.
Industry = Networking & Communication Devices
Below is a comparison of some key ratios for Cisco over the last 4 years:
2009
2008
2007
2006
EPS
1.05
1.31
1.17
0.89
P/E
22.86
12.48
23.13
30.72
Price/Tangible Book
4.15
3.37
2.76
2.07
Price/EBITDA
15.32
8.98
16.90
20.46
ROE
16.8%
24.5%
26.5%
23.7%
Debt/Assets
0.35
0.34
0.37
0.41
Current Ratio
3.2
2.6
2.4
2.3
It is important to notice a few different things from the chart above. EPS overall is increasing,
which is good for current shareholders. The increasing Price-to-Tangible Book Value ratio
indicates the increased risk of shareholders receiving a greater potential loss in the event of
liquidation. The decreasing ROE indicates that the shareholders are increasingly getting less of
a return on their investment in CSCO. The company has a good capital structure, especially with
debt being used to finance less than 40% of total assets and with that decreasing over time.
Cisco’s liquidity is also increasing over time, which indicates that it is increasingly more capable
of paying off its short-term obligations.
Performance over the past 5 years compared to competitors: HPQ, JNPR, S&P500 and the
NASDAQ. Over the last 5 years, HP appears to be the leader with Cisco in second.
Stock price change over the past 2 years: Cisco, as well as its competitors, stock price begins to rise
as the market turns around, but unlike the S&P 500, Cisco as well as its major competitors have reached
their prices from before the market crashed.
Stock price change over the past year compared to competitors: Cisco, as well as its competitors,
is seeing rising stock prices in the past year, but compared to the majority of its competitors, Cisco has
not seen as large of an increase.
Discounted Cash Flow
Some of the growth rates used in the DCF above were from Yahoo Finance. The only growth rates that
did not come from Yahoo were the 5% for 2016-2019 and the 2.5% second stage growth rate. I used
these growth rates because I felt that they were both conservative and reasonable.
The table below shows a sensitivity analysis, where I changed the first stage growth rates as well as the
discount rate. Please note that the first stage growth rates that I used in the sensitivity analysis were
held steady for the first 10 years.
Sensitivity Analysis
Growth Rate
Discount
Rate
2%
4%
6%
8%
10%
12%
14%
10%
$7.64
$8.82
$10.18
$11.77
$13.61
$15.74
$18.20
12%
14%
16%
18%
20%
$6.16
$5.20
$4.53
$4.03
$3.65
$7.04
$5.89
$5.09
$4.50
$4.05
$8.05
$6.68
$5.73
$5.03
$4.50
$9.22
$7.59
$6.46
$5.63
$5.01
$10.57
$8.63
$7.30
$6.32
$5.58
$12.13
$9.83
$8.25
$7.10
$6.24
$13.92
$11.20
$ 9.34
$7.99
$6.98
The intrinsic value for CSCO of $11.90 is much lower than the current stock price of about $26.60 (as of
4/9/10). The sensitivity analysis above shows that even with a 10% discount rate with a 14% constant
growth rate, CSCO is still significantly overvalued.
Wall Street Analysts’ Opinions:
Current Month
Last Month
Two Months
Ago
Three Months
Ago
Strong Buy
14
14
14
15
Buy
16
15
14
14
Hold
6
7
8
8
Underperform
1
1
1
1
Sell
0
1
1
1
Data provided by Thomson/First Call
S&P Recommendation:
12 Month Target Price as of March 20, 2010 = $30.00
Qualitative Risk Assessment: Medium
S&P Quality Ranking: B+ (Average)
S&P Fair Value Rank: 4+ (Stock is moderately undervalued)
Volatility: Low (CSCO had low price volatility over the past year)
Technical Evaluation: BULLISH (since Feb. 2010)
4 STARS = BUY
Sources
Bigcharts.com
netadvantage.standardandpoors.com
google.com/finance/
yahoo.com/finance/