Insights

Cisco Systems, Inc. – Successful transformation from hardware to software

Description

Cisco Systems, Inc. designs, manufactures, and sells Internet Protocol (IP)-based networking and other products related to the communications and information technology (IT) industry and provide services associated with these products and their use. The Company provides products for transporting data, voice, and video within buildings, across campuses, and globally.

Investment Rationale

We are positive on Cisco (CSCO) due to its successful transformation from a pure networking company to focus on software capabilities. We believe its innovative software offerings along with its recurring subscription-based revenue offers defensive yet meaningful growth opportunities.

1. Software revenue resistant to slowdown in IT spending. CSCO’s recurring software revenue will provide a strong defense against lower enterprise IT spending. Software has not only been the strongest area of growth for the last decade, it was also the most resistant business segment during the Global Financial Crisis. Although CSCO has exposure to enterprise companies, we think that CSCO’s high portion of software and recurring revenue would shield its earnings from lower demand from webscale and service providers. When viewed on a 2-year average basis, software order growth remained strong at ~4% and is likely to achieve mid-single digit revenue growth in the long-term. In addition, strategic partnerships with Google and Amazon Web services in FY19 would ensure that CSCO get a share of the pie when capex resumes for the webscale companies.
2. Strong product growth in switching and security. Product revenue was up 7% YoY in 4Q19, led by 6% growth in Infrastructure Platforms. We also see double-digit growth in switching on the backdrop of strong demand for CSCO’s Catalyst 9K (campus) and Nexus 9K (data center), partially offset by a decline in routing due to weakness in service provider spending. Security revenue also grew 14% YoY in 4Q19, which marks the sixth consecutive quarter of double-digit growth, as CSCO invested in new Artificial Intelligence (AI)/Machine Learning (ML) solutions to improve network management across the entire enterprise network.
3. Trade war unlikely to put a dent in CSCO’s hide. CSCO mentioned that they are unable to proceed with deals with service providers and enterprises in China due to the trade war. However, we think it is unlikely to affect CSCO’s top line as China accounts for less than 3% of FY18’s total revenue.