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Cisco’s Renaissance Is Just Beginning

September 19, 2018

Cisco Systems (NASDAQ:CSCO) is a company trying to rebirth itself and that’s a tough act for any company. Known for its switches, routers and other hardware, CSCO stock was slow to awaken to the major changes in the technology markets that went from businesses buying and owning their own in-house equipment to subscribing to outsourced cloud services.

And shareholders have been paying the price with this miss by management. The stock, up until last year, had a lousy record for investors. Shares moved up only 1.25% from September 2007 to September 2017 and even with a bit of a dividend, the total return was a meager 21.47%.

Compare that to the return of the S&P 500 Index of 103.58% and it looks embarrassing. But it gets even worse when comparing it to its peers in the technology market with the S&P Information Technology Index turning in a return of 189.08%.

Ouch.

But the past twelve months have been to show the turn in the market’s view of the company. The shares have turned in a return of 50.03%, which has outpaced the S&P 500 by 31.77% and the technology market index by 20.98%.

What’s changed is that CSCO is now fully engaged in transforming itself from just the equipment to software and cloud service support. The goal is to get revenue from reoccurring subscription services from 32% in its fiscal 2018 to 50% or more by 2020. And it would like to keep pushing that makeup of its revenues even higher — much like has been done by other big tech companies such as Microsoft (NASDAQ:MSFT).

It looks like it might well continue to be successful. For out of that 32% of its overall revenues in reoccurring, 70% of that was in software sales for the past fiscal year.

Even with its switch and hardware products, Cisco is moving to bundle software and related services as part of its unit sales. Its Catalyst 9000 series switches are successfully being bundled with subscription software with contracts running from three to seven years.

And thanks to its acquisition of Meraki back in 2012, it has some great offerings for cloud and web-based services for a variety of customer bases.

Speaking of acquisitions, CSCO is eager not just to build out its own service offerings but also by acquiring companies and related talent. It has done 37 deals in just the past three years amounting to $13 billion. And with nearly $47 billion in cash and equivalents, it has an ample war chest to do more deals. And some are eyeballing Red Hat (NYSE:RHT) and others that could make for attractive targets for their software and services to bolster Cisco’s efforts for more services and less hardware for its product mix.

This cash hoard is also backed up by some significant borrowing capabilities. The bond and credit markets are very eager for offerings by companies with its credit capabilities and with only $20 billion in long-term debt and a debt to assets ratio at a mere 23.5% – Cisco could easily borrow to get larger scale deals done.

Meanwhile, the company on an operating basis is quite healthy. Operating margins are at a fat 25.0% but given the size of the company’s assets including all of that cash, the return on assets and shareholder’s equity is an embarrassing 0.1% and 0.2% respectively.

Revenue is what it needs. And it has been working on that front with its move towards reoccurring revenues. While revenues were sliding quarter after quarter from its fiscal 2016 through 2017 – 2018 has seen the turn with quarter after quarter resulting in revenue gains with the final fiscal 2018 quarter ending in July showing gains of 5.86%.

And it also has a hedge in the ongoing trade tirade going on with China and the US. Most of its core products and services aren’t welcome in China – so less is at stake than for its peers in the technology space with the largest share of its sales in North America and Europe as well as the Middle East and Africa (EMEA).

Bottom Line on CSCO Stock

With the company’s rebirthing efforts underway — and Cisco stock beginning to reflect this — investors can be a bit patient. And with a dividend sitting at 2.79%, upped by 14.87% on average for each of the past five years, shareholders are being paid to work with the company.

And with a market valuation of the company at 5.04 times book and 4.6 times sales, it is at a discount to other companies such as Microsoft, which is further along the path from one-off product sales to reoccurring income. Microsoft is valued at more than twice Cisco’s book valuation and at a major premium over Cisco’s price to sales.

Right now, I’m with management in its quest for a better revenue mix. And I see Cisco as being a success in its transformation.

Neil George is the editor for Profitable Investing and by company policy does not have any current holdings in the securities mentioned above.