By David Gross
One of the questions I'm answering a lot these days is whether F5 and Riverbed are overvalued. But no one's wondering if the same is true for their "dominant" competitor Cisco. In response to its limp stock performance, Cisco recently announced that it will increase the cap on its share buyback program $10 billion.
Share buybacks used to be seen as some sort of internal endorsement of the company. But that was before technology companies started piling up cash without paying much in the way of dividends. Now they're often used as gimmicks by cash rich companies to try to boost a stock that's treading water while smaller competitors are doing something far more important to their future stock price - taking market share.
While Cisco still owns the switching and routing markets, their overdiversifications into other areas have caught up with them, and now they're doubling down on these bad investments by throwing more shareholder capital at a buyback program that will do nothing to stop John Chambers wild ride into conferencing, consumer devices, and a product that will make the Newton look like a success, the Cius. After years of tremendous success naming products after numbers, Cisco somehow decided to go with something that sounds like it was ripped out of a High School Latin textbook.
It's kind of interesting how the stock has gone nowhere since John Chambers got bored selling switches and routers. Over the last five years, Cisco has spent over $10 billion buying companies like Scientific-Atlanta, WebEx, Pure Digital, and others that have brought it closer to end users, and expanded its presence out of the guts of the network. Over that same period, the stock has gone up 14%, or about 2% per year. Juniper, meanwhile, which hasn't had the resources to buy all sorts of consumer device companies, has seen its stock rise a more respectable 42% over the same period. Riverbed and F5 are up over 300%. So how did Cisco become such an underperformer?
Any Idiot Could Run This Joint
Former Fidelity fund manager Peter Lynch once said that when evaluating companies, he likes to hear that "any idiot could run this joint, because someday, any idiot probably will". Cisco found a person who could fit that description in 1995, but it did eventually catch up with them.
For all his attempts to overdiversify the company, John Chambers still has to contend with the fact that nearly 2/3rds of his product revenue comes from switches and routers. While those products aren't exciting enough for Chambers or Cisco IR to talk about these days, they're still growing in spite of their size, with switch revenue up 25% year-over-year. Moreover, these devices are built on routing technology Cisco built internally, and the switch business has grown out of two acquisitions, Crescendo and Kalpana, which were made before Chambers took over. The third major switch acquisiiton, Grand Junction Networks, was made in 1995 soon after he became CEO. The tens of billions of spent on new companies since then have done remarkably little to add to the top line, although they've done a lot to make Chambers speeches more interesting, because he wasn't about to go all over the world talking about enhancements to OSPF or spanning tree.
Before Cisco really lost its focus, it was a lot better about killing off products from bad acquisitions. In 2001, it realized its $500 million buyout of Monterrey was a mistake, that it was not going to compete strongly in optical switches, and it killed the product line. Yet its $6 billion acquisition of ArrowPoint has created a product line, the CS-series, which is getting crushed today by F5 and Citrix's Netscaler. But it won't admit that it's strength is in layer 2-3, not layer 4-7, regardless of how bad a beating it takes. Chambers used to say something about being 1 or 2 in a market like GE traditionally was, but now market position is losing out to market hype, and it's remarkable how much more is being written about the Cius, telepresence, and how little is being said about the proprietary VLAN and routing protocols which are the foundation of Cisco's $100 billion+ market cap.
Cisco can blame Federal spending levels, the economy, Chambers' receding hairline, or whatever it wants for its current struggles. But there's one thing the company can do to fix things, one thing that will stop the share losses to smaller competitors, one thing that will allow it to dominate for decades - focus on routers and switches. But this won't happen with the current CEO.
Instead buying back shares, the board should be bringing in new leadership.