Cisco Systems, Inc.: Backstory

Cisco Systems is a behemoth. It is the world’s largest supplier of high-performance computer networking systems. It was founded in 1984, and currently has over 70,000+ employees.

Geographically, it is everywhere. In 2015, 60% of revenue came from the Americas, 25% from Europe, the Middle East and Africa (EMEA), and 15% from the Asia-Pacific region.

It bread and butter is routers and switches. They still account for nearly  60% of sales. Cisco dominates these categories with strong 50-60% market share. It is the elephant in the room.

What about the remaining 40%? New forays into security, video conferencing, collaboration, and data-centers account for the remainder. But these categories are probably going to drive any future growth, as they are growing at healthy 10-15%/year clip. 

What are the biggest threats to Cisco? The biggest known threats are the erosion of its near monopoly in its core business: sales of  routers and switches are nearly flat in the past couple of years. The company is increasingly challenged by SDN or software defined networking. It has been losing share in the high-end 10GbE & above switching market.

Despite these threats, CSCO has increased revenues at over 4%/year from $36 billion in 2009 to $49 billion in 2015. In the same period net income has grown from $6 billion to $9 billion at a 5.5%/year clip. Stock repurchases have reduced the number of shares outstanding at approximately 2%/year between FY 2009-2015. Due to the decrease in share count the EPS has actually increased by 7.5%/year (=5.5% + 2%) to $1.76.

Through all of this CSCO has been able to maintain healthy EBIT and net margins of over 20% and 15%, respectively. These impressive numbers actually understate CSCO’s operating performance.

margins

Why? Net cash (cash + short term investments – total debt) on the balance sheet has ballooned from $25B to $35B between 2009 and 2015, and constitutes over a third of the capital. A lot of this cash is trapped overseas, and cannot be easily distributed to shareholders. Due to this “cash drag”, the after-tax operating return on capital employed (equity + debt – cash) is nearly an enviable 30%.

CSCO is no longer the turbo-charged growth company it once was. As it has matured, it has started doing the things that gracefully aging tech companies do. It has increased the role of debt in its capital structure (the debt/capital ratio increased from 20% in 2009 to 30% in 2015). Unable to profitably invest the gushers of cash, it started paying a dividend in 2011, and doing decent sized buybacks (shares decreased from 5.8B in 2009 to 5.1B in 2015). Currently, the stock pays a $1.04/share dividend/year, which amounts to a juicy 3.6% yield.

In the current fiscal year, it is on target to increase its EPS to nearly $2.30. Superficially, based on its current stock price, it is selling at a 12.6 PE, which seems attractive.

Personal Backstory

In 2011, I was a clueless idiot (I am happy to admit that I still am mostly clueless; just more humble than I used to be). I had read a ton of investing books and blogs, and thought I had figured it all out. I have a natural contrarian streak (which by itself is neither positive nor negative), and am generally disciplined.

So when I perceived a weakness in CSCO the stock, I started accumulating. My analysis was overly simplistic (some shorthand like PE-ex-cash less than 10x or something). By the end of 2011, I had made CSCO my largest position – nearly 20% of my portfolio at an average price of $18.50.

Starting in 2013 and 2014, I started selling my position. I sold most of it out at an average price of $26.50. On the stock itself, I made about 11%/year; dividends, and all the covered calls I wrote spiced this up to about 15%/year, which isn’t too shabby.

Unless, that is, you compare it with the S&P, which I think did better!

But overall, I thought it turned out fine (largely due to luck!).

So why am I bringing CSCO up after all this time? Well, I hold a final sliver in my portfolio, and am contemplating whether I should hold on to it, or jettison it now that CSCO is around $29/share. Since I have been wanting to practice some intrinsic valuation, I thought I’d try to put something together (in the next blog) and determine my future course of action.

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