Cisco's New Targets Show How Challenging Its Transition Is

If there is a silver lining for the long-term low returns and EPS growth targets that Cisco Systems Inc. (CSCO) has just provided, it is that markets were not bothered by the numbers. Cisco closed down 1.4% on June 28, the day the outlook was given, slightly surpassing the Nasdaq 1% gain.

That, of course, has a lot to do with how cheap Cisco shares are: With the giant trading network less than 13 times its fiscal 2018 (ending July 2018) EPS consensus estimate even after a giant Nasdaq Rally, markets are not counting on anything more than modest earnings growth in the coming years.

But for those hoping that Cisco's aggressive moves to increase its software and services exposure will pave the way for the company to return to double-digit earnings growth, its goals should be considered disappointing, a hard reminder of how much of a Cisco Front-End Exposure to hardware franchises that are facing great long-term pressures will remain even as their software revenues and subscriptions increase.

At its 2017 analyst day, which was held at Cisco's annual Cisco Partner Conference Live, Cisco predicts it will only grow 1% to 3% annual revenue growth and an annual growth of mid-digit EPS In the next three to five years. The outlook was provided during CFO Kelly Kramer's portion of the Cisco Analyst's Day presentation, and can be found on Kramer's presentation slides.

Growth targets are lower than Cisco issued at the end of 2013, when it forecast growth of 3% to 6% of revenue and growth of 5% to 7% over the next three to five years. Assuming Cisco reaches a consensus of $ 2.38 for fiscal year 2017, EPS's compound annual growth since fiscal year 2013 will have been around 4%, slightly missing its target range.

In addition: Despite its software / services change, Cisco only forecasts that its margin growth will be flat to positive. On the positive side, the company promises to continue returning more than half of its free cash flow (FCF) to shareholders.

 The biggest culprit behind Cisco's moderate outlook: The company only expects its "infrastructure platforms" business to cover switching, routing, Wi-Fi and server products, and currently gets only 14% of its software sales. Income growth. In addition, Cisco's "Other" businesses, which include things like video conferencing and cable / telecom video hardware, are expected to decline in a half-digit clip.

That is largely expected to compensate for stronger growth in other areas that Cisco has prioritized. Sales of application software, including subscription-based cloud applications, are expected to grow to a single-digit maximum for a teenage bass clip. Sales of security products, nearly half of which are now software-related, are expected to see growth in low- to middle-aged adolescents. And service revenues are expected to grow at an average one-digit rate.
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Cisco's main problem: its "infrastructure platform" and "other" offerings account for more than two-thirds of its current product sales, which in turn represent 74% of its total revenue. On the other hand, a large part of the 26% of the income from the services continues supposing contracts of support and maintenance for the products mentioned above.

Cisco expects its deferred revenue balance, which totaled $ 17.3 billion at the end of its April quarter, to register a compound annual growth rate (CAGR) of 5% to 10% over the next three years, thanks to a CAGR of 20 % Expected for the product Deferred revenues related to software and subscriptions (currently $ 4.4 billion). If it were not for some sales push in the deferred revenue balance, Cisco's revenue growth target would look a bit stronger.

But given the impact of this momentum in recent quarters, we could be seeing only a 2% income growth difference in the short term and - as several software businesses largely transition to subscriptions - possibly less long-term , finished. It is also worth bearing in mind that delivering 1% to 3% sales growth would be a clear improvement over short-term sales trends: Cisco revenue fell 1% year-on-year in the April quarter, And has been guided to fall 4% to 6% The quarter of July.

A deterioration of the major secular challenges facing Cisco hardware operations provide context to the company's sales prospects. Some of the great:

    The adoption of third-party software-defined network platforms (SDNs) will enable enterprises to more easily deploy product switches within data center networks and adoption of network feature virtualization (NFV) .

    Cloud giants, such as Amazon, Google and Facebook, rely heavily on switches they designed themselves or open source switch designs from initiatives such as the Facebook-led Open Coupon Project (OCP). And as Cisco customers move more workloads to cloud infrastructures with these switches, they do not need to spend as much on switches for their own data centers.

    Telecom's capital spending continues to be under pressure, as fixed and mobile telephony operators who see little or no revenue growth attempt to restrict their spending.

    Switching rivals such as HP Enterprise Inc. (HPE), Huawei and Arista Networks Inc. (ANET) have been taking action collectively. Similarly, Juniper Networks Inc. (JNPR) and Nokia Oyj (NOK) have been providing stiff competition in the carrier router market.

In the midst of all these challenges, Cisco has been doing some pretty smart things. The launch of network software solutions such as the ACI SDI platform, its Tetration data center analysis software and (more recently) its DNA platform to automate office network functions that IT administrators have to do manually serve To better differentiate the company's hardware platforms. They also increase the amount of long-term revenue that Cisco can produce from those hardware customers who remain loyal, the additional expense customers can justify due to benefits such as lower IT operations costs and better security.

 An example of how Cisco expects software subscriptions to grow the revenue opportunity for a switching product line.

Cisco is also using M & A to expand into adjacent software and services markets that complement its existing product line: Examples include its $ 3.7 billion acquisition of APM software company AppDynamics and its purchase of more than $ 1.4 billion Service Provider Jasper Technologies. And their efforts - both through mergers and acquisitions and organic investments - to increase their exposure to a security market that continues to be a strong point for IT spending - have generally borne fruit.

The net result of all these moves, however, may simply be to allow Cisco to provide modest organic growth in the coming years. That could prove to be a better outcome than some IT colleagues, such as HPE and IBM Corp. (IBM), could face because of their own secular pressures. But those who expect something better could still end up disappointed.