Arik Hesseldahl

Recent Posts by Arik Hesseldahl

There’s Nowhere to Go but Up at Cisco, Sterne Agee Says

The planned turnaround at networking giant Cisco Systems isn’t going to be easy, and it isn’t going to be quick, but it is going to happen. That makes now about as good a time as any to buy its shares, says Sterne Agee analyst Shaw Wu in a note to clients issued today.

Having closed on Friday at $14.97, the price of Cisco shares is nearing its lowest point in about five years (Cisco hit $14.18 in March of 2009). CEO John Chambers has blamed toughening competition in its main networking business, lower profit margins resulting from a product transition and a drop in government spending for many of its troubles. A significant restructuring is coming some time before the end of the summer that will combine offering retirement packages to eligible employees and laying off others. It’s also possible that other parts of Cisco’s business may be sold, spun off or shut down.

Chambers’ plan is to trim Cisco’s operating costs by $1 billion a year. Meanwhile, the video business that Chambers constantly talks about is starting to get interesting and competitive, and other products, like its blade servers, are starting to show some traction. And by the way, the Internet isn’t exactly getting smaller, you know.

Whatever it is, it better happen soon, Wu says, because investors are getting impatient. “In sum, we believe Cisco is fixable and not structurally flawed, but admit we need to see more dramatic steps be taken,” he writes.

While some investors have been calling for Chambers to step down, Wu isn’t with them. “From an investor standpoint, most believe that Cisco will be very difficult to turn around and that a management change is needed. While we do not believe that John Chambers needs to go, as we believe he has proven to be one of the greatest managers and visionaries of the modern era, we do believe he needs to make bigger moves than what has been done so far.” One suggestion? Boost the dividend to 3 percent from its current 1.6 percent.

Also? Cisco may have to take some “bitter medicine” on the price of its switches and other networking gear. Many Cisco customers and its channel resellers told Wu that Cisco’s prices are too high when compared to competitors, and that it may be pricing itself out of the market. “Many believe that Cisco still deserves a premium, but 50 to 100 percent seems a bit excessive,” he writes. “Because of this, we believe Cisco will likely need to take the bitter medicine of lower gross margin for longer-term good.” He cut his assumptions on Cisco’s gross margin accordingly from about 62 percent to a little higher than 55 percent.

That said, most of the the bad news at Cisco is priced in, making its depressed price a fair buying opportunity, he says. “We believe the Cisco story is getting better, and we’d rather be a buyer at these depressed levels than wait for obvious evidence of improvement. By then it may be too late.”

Wu still rates Cisco shares a buy, with a price target of $25, which is a drop from his previous target of $29. He also lowered his fiscal year 2012 estimates on Cisco’s revenue and per-share earnings to $45.9 billion and $1.50 per share, from $46.5 billion and $1.80 a share. The new target price represents a multiple of 12.5 times Cisco’s projected calendar year earnings of $1.62.

Wu also thinks Cisco will start setting more realistic expectations going forward, and back away from its projecting a long-term annual growth rate of 12 to 17 percent, which, he says, “no one believed anyway.”

Given all that, Cisco’s close to turning the corner, he says, though it won’t happen right away. “We realize that Cisco may take a few quarters in fixing itself, but we believe management will make the right moves in restoring investor creditability.”

(Image borrowed from the 1938 Warner Bros. classic animated short, Porky In Wackyland.)

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