November 11, 2010 / 6:17 PM / 9 years ago

Analysis: Government deals, once boon for Cisco, now problem

NEW YORK (Reuters) - Government, long a big, steady customer for Cisco Systems Inc (CSCO.O), has turned into a major headache for the company as debt-burdened countries and some states stopped buying new equipment.

An abrupt drop in spending by European nations and U.S. state and local governments is partly to blame for a bleak forecast that rocked global markets.

The slowdown also raises concerns that the company is neglecting its main business, as Cisco is expanding beyond its traditional network equipment business into everything from video cameras to computer servers.

The issues speak more to problems at Cisco than the entire technology industry, investors and analysts said, many of them noting that other tech firms are recovering more strongly.

Chief Executive John Chambers cited weak public spending as well as service providers, namely cable companies that have been losing customers, but said he saw the slowdown as “a couple of air pockets.”

“It does seem somewhat Cisco specific. I think they have more exposure to a couple of areas that are weaker, in particular the public sector,” said Morgan Stanley analyst Ehud Gelblum. Public spending accounts for around 20 percent of Cisco’s business.

SPREAD TOO THIN?

Gelblum and others also said Cisco’s ambition of diversifying Cisco’s business may be hurting sales of routers and switches, its bread and butter.

“We believe the order shortfall could be more than the ‘air pocket’ described by Chambers, and instead could be the first signal that Cisco is losing share in some of its core markets as its focus on growth has diverted attention from its core businesses,” Gelblum said.

Cisco shares closed down 16.2 percent on Thursday on the Nasdaq, on disappointment over the revenue outlook it announced a day earlier. The decline — which occurred in trading that was more than 10 times Cisco’s average daily volume over the past 50 days — wiped out about $22 billion of Cisco’s market capitalization.

Cisco is the world’s top manufacturer of routers and switches that direct Internet traffic. Customers include a range of corporations, including most major global phone and cable companies and a variety of government agencies.

To preserve double-digit revenue growth, Cisco has ventured into new areas, developing videoconferencing products and buying consumer products companies, including the maker of the Flip video camera.

Oppenheimer analyst Ittai Kidron said Cisco’s acquisition of videoconferencing firm Tandberg and its entry into new businesses like data center servers appeared to be gaining traction.

“But it’s also losing market share in its core markets - namely, routing, switching and security,” Kidron said in a note to clients, recommending they stay on the sidelines until the outlook becomes more clear. “We expect market share figures over the next 2-3 quarters to more clearly depict the share losses.”

STILL A BELLWETHER

While shares of network equipment rival Juniper Networks (JNPR.N), as well as International Business Machines Corp (IBM.N) and Dell Inc DELL.O fell, the decline in the rest of the overall sector was limited, showing investors betting that the problem may be Cisco’s own.

“People are not throwing out the tech baby with the bath water,” said Fort Pitt Capital Group senior analyst Kim Caughey Forrest.

However, she and others warned against dismissing it as an isolated issue, since Cisco is normally considered one of the technology sector’s bellwethers because of its broad, global operations.

Since Cisco’s most recent quarter ended October 30, later than the September 30 at many peers, its outlook and comments on recent orders are seen as a more up-to-date indicator of industry trends.

“I think it’s more of a Cisco problem. However, I think that their commentary on the state of IT is always important, so you still have to double check your tech holdings in light of what Cisco says,” said Caughey Forrest. She owns Cisco shares but said she was not buying more.

Chambers said orders in the past quarter were below initial, internal estimates by more than $500 million. As a result, he forecast that revenue would grow just 3 percent to 5 percent in the current quarter, short of Wall Street’s forecast 13 percent.

That was a big disappointment for a company known for solid management, and seen as a top beneficiary of the surge in global wireless and Internet traffic.

It was also the second quarter in a row that Cisco gave a weaker-than-expected outlook. A disappointing sales forecast and Chambers’ warning of “unusual uncertainty” among customers sparked a sell-off last quarter.

SOLID BET LONG TERM

While most analysts said Cisco’s shares could remain under pressure until it shows signs of recovery, many said the company was still a solid bet in the long run.

More consumers around the world are using mobile phones and going online, not just to email or browse websites but also to download movies and songs, and chat online —all activities that require advanced network equipment.

Fifth Third Asset Management holds Cisco shares as part of its $18 billion portfolio, and its president and chief investment officer, Keith Wirtz, said he might buy more if the price falls further.

“Professional managers are susceptible to any excuse to sell,” he said. “I think people are looking for a reason to harvest some of the profits right now.”

Jefferies & Co analyst William Choi maintained his “buy” recommendation on the shares.

“Cisco is facing some unique issues due to the breadth of its product portfolio and customer segments,” he said. “However, we believe Cisco is well-positioned longer term to drive new product cycles, gain share and penetrate new markets.”

Additional reporting by Jim Finkle; Editing by Kenneth Li, Robert MacMillan and Steve Orlofsky

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