- According to Synergy Report, Cisco managed to maintain market share in switching/router markets in Q4 2015.
- This despite Cisco's worrying revenue slowdowns and declines in the two key segments.
- Cisco does not appear to have much downside at this point and this makes the shares suitable for long-term investing.
The world’s largest manufacturer of networking hardware Cisco (NASDAQ:CSCO) recently announced an overall solid Q4 2015 earnings report but one that contained some weak points nonetheless. Cisco reported fourth quarter revenue of $11.8B, good for 2% Y/Y growth. When adjusted for the sale of the company’s set-top box that it’s selling to Paris-based Technicolor, adjusted revenue checked in at $11.93M, $170M better than estimates. Meanwhile, non-GAAP EPS of $0.57 was $0.03 better than estimates by analysts. Investors were excited when Cisco announced a 24% dividend hike and a huge $15B dividend buyback program.
Looking at Cisco’s Q4 earnings slides where the company breaks out its segment performance, three points of concern immediately jump out:
- Cisco’s core switching business, the company’s largest business segment bringing in 29% of revenue, posted a 4% Y/Y revenue decline to $3,483M. This was quite a radical shift from a year ago when the business was growing in double-digits.
- Cisco’s router business, its third-largest, accounting for 16% of revenue, grew 5% to $1,845M, a slowdown from a year ago when the business grew in double-digits.
- Cisco’s data center business (7% of revenue) posted a 3% revenue decline to $822M after posting growth in 20s-percentages in recent quarters.
Cisco blamed a weak macroeconomic environment for the declines and growth slowdown in its switching, router, and data center businesses. There is a general air of macroeconomic uncertainty that is leading to technical teams delaying their IT spends as they ponder about their technical roadmaps. To underscore just how bad the situation is, consider that Cisco’s data center business, which consists of UCS servers, has been the company’s fastest-growing segment and posted a 24% revenue jump during the first quarter. A 3% decline in the segment during the most recent quarter was, therefore, a pretty dramatic turnaround of fortunes.
Cisco’s Switching/Router Market Share Intact
Whenever a company records revenue slowdowns or declines in its business segments, the common fear among investors is that its rivals could be busy eating its lunch. Cisco is still by far the market leader in the company’s core switching and router business. However, the company has been facing increasing competition especially in the service provider router market from the likes of Alcatel-Lucent (NYSE:ALU), Juniper Networks (NYSE:JNPR), and Huawei. Cisco pinned the recent slowdown in router growth from weak cap-ex spending by telecoms.
But the good news is that Cisco’s switching/router market share has remained intact despite the headwinds it has been facing. According to a recent report by Synergy Research, Cisco’s share of the $41B switching/router market (2015 revenues) remained unchanged at 56% during Q4 2015, the same as it was a year ago. None of Cisco’s main competitors including Juniper, Huawei, HPE, and ALU even comes close to this level since Synergy reckons that each has a switching/router market share in the 6%-8% region.
The total market grew 3% in 2015 compared to 2014 mostly aided by growth in Ethernet switching. Enterprise Ethernet switching remains the biggest sub-segment accounting for 60% of the global switching/router market. Synergy pegs Cisco’s share of the Enterprise switching market at about 62%.
Cisco is most dominant in enterprise routers where it commands a 69% share of the market and its least dominant position is in service provider routers (mostly telecoms) where it holds 42% share of the market.
Overall Cisco is most dominant in the enterprise switching/router market with HPE being the only other player with double-digit market share. The service provider side is more fragmented with ALU, Juniper, and Huawei all having double-digit shares of the market.
SDN Not A Major Threat
Other than competition from rivals, another fear that commonly pops up in the minds of Cisco investors whenever the company posts revenue slowdowns or declines in its core switching/router business is that SDN, or software-defined networking, could be responsible. SDN is a cheaper alternative to traditional networking and combines a little networking hardware with a software overlay.
But these SDN fears are mostly exaggerated for two main reasons: Cisco has ACI, its own take on SDN, and a vast majority of companies implementing SDN still use Cisco’s proprietary hardware as the underlay.
Currently, there are two main SDN flavors in the market: NSX, owned by virtualization company Vmware (NYSE: VMW), and Cisco’s ACI. During its most recent quarter, VMware announced that NSX had reached an annual revenue bookings rate of $600M with revenue from NSX growing more than 100%. But Cisco is no laggard in this regard either. Cisco announced during the fourth quarter earnings call that ACI revenue had crossed the $2B annual revenue run rate and was growing at 100%. Moreover, most VMware customers still prefer to use Cisco’s hardware since VMware is a pure software company (with a few storage hardware products courtesy of its parent EMC). Cisco already has a large installed customer base due to its long-running history as the networking hardware market leader. Customers who are implementing SDN find it cheaper to simply use most of their Cisco hardware other than trying to switch to a rival’s products.
SDN, therefore, presents both a threat and an opportunity for Cisco. But so far, there is little evidence that it’s causing much harm to its traditional hardware business.
Despite ongoing secular headwinds, Cisco has been able to maintain market share in its core switching/router businesses against its rivals, which implies they are feeling the heat too. A key takeaway from Cisco’s latest report was that China had started growing after a long period of underperformance. The same is likely to happen to the North American market once the uncertainty surrounding the economy lifts off.
Cisco shares are down 3.6% YTD. But with the shares yielding a healthy 3.97% and not much downside at this point, Cisco shares could go on to make solid long-term gains once growth normalizes.