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After H-P plans split, attention turns to Cisco

Cisco CEO John Chambers addresses the audience during his keynote speech at the annual Consumer Electronics Show (CES) in Las Vegas, Nevada January 7, 2014. REUTERS/Robert Galbraith

Hewlett-Packard (HPQ) CEO Meg Whitman and her board agreed this week to split up the venerable PC maker just a few years after categorically rejecting the idea. Now the crowd of analysts and investors who see value in breaking up aging tech giants is moving on to new targets. Next up may be networking pioneer Cisco Systems (CSCO).

Cisco is not in nearly as dire straits as H-P – its revenue and profit growth have only lately tailed off amid weak corporate spending on information technology and growing competition from cloud-focused upstarts. Palo Alto, Calif.-based H-P, meanwhile, increased sales last quarter for the first time in three years.

But Cisco’s stock price hasn’t kept pace with its long-term, improving fundamentals. Over the past decade, sales have doubled and net income is up 67%. But the stock has gained only 26%, marking only a fraction of the market’s overall rise over that period.

Cisco's stock price has lagged gains in revenue and profits over the past 10 years.
Cisco's stock price has lagged gains in revenue and profits over the past 10 years.

Attention turned to Cisco after H-P’s decision, which itself followed recent moves by eBay (EBAY), IBM (IBM) and SAIC, now trading as Leidos Holdings (LDOS), among others tech companies deciding to split up or sell off some businesses. Indeed, analysts have also mulled the odds of fellow Dow component 3M (MMM) breaking itself up.

Cisco “is too big and has been too slow to combat an onslaught of nimble players,” RBC Capital Markets analyst Mark Sue wrote on Monday. “A dramatically different structure may be needed to unlock Cisco’s potential and accelerate its pace (of growth).”

In the view of break up proponents like Sue, the blue-chip firm could retain its slower-growing hardware units like routers and switches and spin-off faster-growing businesses like cloud services, wireless and data security.

A split might also offer long-time CEO John Chambers, 65, an opportunity to retire, though he’s shown little interest in discussing the topic. The company has shot down numerous rumors of an impending Chambers retirement announcement over the past few years.

To split, or not to split?

The theory behind the split-up scenario is that investors are failing to appreciate – and properly value – the parts of Cisco that have a brighter future. The company trades at a price-to-earnings ratio of just 11 based on estimates of next year’s net income and an enterprise value of only 2 times next year’s sales, much lower than faster-growing tech companies. Two separate companies could be worth $40 per share versus the current price of around $25 now, RBC's Sue estimates.

Still, there are no guarantees that separate companies would have a higher overall valuation than Cisco’s current low-end ratios suggest. Some much smaller networking competitors, such as Arista Networks (ANET), trade at much higher valuations but others, like Juniper Networks (JNPR), are at about the same level.

It is also possible, as Sue argues, that two smaller companies would be more nimble and focused on their own.

But there are also plenty of break up opponents, such as UBS analyst Amitabh Passi. Cisco’s many divergent businesses “are often pulled together to drive architectural sales,” Passi wrote on Monday. “Sure, different businesses have different growth profiles, but we don’t see a compelling case to break apart the company when there are cross-selling and synergistic advantages.”

CEO Chambers isn’t expected to take up the break up approach, either. Shareholders in favor of a split may need support from an activist investor or two. Until then, a Cisco split will likely remain a hypothetical scenario.