Why does Cisco Systems seems to be stuck in transition mode?

Market Realist

Business overview: A must-know investor's guide to Cisco (Part 2 of 8)

(Continued from Part 1)

Cisco’s priorities

In April 2011, Cisco announced key, targeted actions intended at simplifying and focusing its organization and operating model, to align its cost structure given transitions in the marketplace, divest underperforming operations, and deliver value to shareholders. Under CEO John Chambers, Cisco decided to exit aspects of its consumer businesses and realign the remaining consumer business to support four of its five key company priorities: core routing, switching and services; collaboration; architectures; and video.

Chambers remarked, “Cisco believes one of the key differentiators over the years has been its ability to capture market transitions, which drive innovation. At the heart of these transitions—cloud, mobility, video, any device and social—is the network.”

Cisco seeks to drive the market transition in virtualization and cloud in the enterprise data center market through the convergence of networking, computing, storage, and software technologies. It forayed into the data center space in 2009 with the Unified Computing System (UCS) platform and Cisco Nexus product families, which are designed to integrate the previously segregated technologies in the enterprise data center with a unified architecture. Cisco is also developing cloud-based product and service offerings through which customers can develop and deploy their own cloud-based IT solutions, including software-as-a-service (SaaS) and other-as-a-service (XaaS) solutions.

As part of the transformation initiatives, Cisco aligned its cost structure and aimed at reducing its fiscal 2012 operating expenses by $1 billion on an annualized basis. As part of this effort, it reduced its global headcount and other costs to optimize the operating model.

Lackluster results and outlook for the two quarters prior to April 2011 coupled with a falling market value prompted the technology bellwether to initiate actions to restore its credibility. In an internal memo to employees back then, Chambers, who has managed Cisco since January 1995, said, “We have been slow to make decisions, we have had surprises where we should not, and we have lost the accountability that has been a hallmark of our ability to execute consistently for our customers and our shareholders.” Cisco was losing dominance in its core routing and switching businesses, and saw market share gains by rivals HP (HPQ), Juniper (JNPR), Brocade (BRCD), and Alcatel-Lucent (ALU) among others.

In 2012, the company saw an evolution toward more programmable, flexible, and virtual networks, and said it intends to lead its transition through a combination of internal development, internal start-ups, acquisitions, and partnering. During the year, Cisco continued to execute on its strategy of “build, buy, partner, and integrate.” In fiscal 2012, despite macroeconomic challenges, including the uncertainty in the European market and lackluster global public spending, Cisco (CSCO) said its revenue increased 7% year-over-year, while its net income was up 24%. Data center segment revenue increased 87% year-over-year, while its legacy routing and switching businesses remained flat; videoconferencing under Telepresence saw a fall in revenue.

In the fourth quarter of fiscal 2013, Cisco’s earnings beat estimates by a small margin and revenue rose, but the company announced 4,000 layoffs that accounted for 5% of the workforce. Chambers attributed the cuts to macroeconomic factors, adding the layoffs were aimed at streamlining the middle management and to realign resources into more profitable units. The layoff announcement coupled with a weak guidance failed to impress the market and shares tumbled. For the two years up to August 2013, Cisco has laid off 12,300 people, following its strategy of exiting consumer markets, while focusing on enterprise software and technology services.

Analysts have questioned the success of the turnaround, as the company has seen its margins in core businesses pressured by increasing competition, and sales have been declining in markets outside the U.S., leading to weaker forecasts. Cisco expects the fall in its core networking equipment business due to product transitions will be compensated by growth in software, services, and security products.

Continue to Part 3

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