By TIERNAN RAY
Cisco is a steal at this price.
CISCO SYSTEMS, LONG A FAVORITE AMONG GROWTH investors, is now better known as a value stock. At $17.82 apiece, there is still abundant value in its shares, which could trade up to 26-27.
Cisco did most of its growing in the early 1990s by selling routers and switches, which connect personal computers in offices by directing the flow of data packets. It got even bigger in the late '90s as the Internet went mainstream. Now Cisco (ticker: CSCO) is moving well beyond its networking roots with its $590 million all-stock purchase last month of consumer-video-camera maker Pure Digital. Since 2007, Pure Digital has sold two million Flip Video cameras, praised for their compactness and simplicity.
The payoff for Cisco is uncertain. But if history is a guide, buying shares at 16.7 times the next four quarters' estimated earnings, just above the price/earnings multiple of the Standard & Poor's 500, will pay off for investors.
Cisco is cheap by other measures, too. It had $4 billion in cash and $25 billion in investments at the end of the January quarter, against $6 billion in debt. Thus, it trades for about 4.6 times the cash on its books, a steal compared to tech stalwarts Microsoft (MSFT), at 9.6 times, or Intel (INTC), at 9 times."We still see significant upside for the stock as [information-technology] budgets recover," says Brian Nelson, who helps run the $3.8 billion Charter Fund on behalf of Invesco Aim. The firm increased its stake by more than 50% in December, adding 25 million shares, according to regulatory filings.
In recent years, as Cisco's growth slowed, investors viewed the stock as an outperformer in bear markets. Now, however, there are signs that business is stabilizing in the traditional networking market. As the tech sector rebounds, a giant with deep resources -- and Cisco is that -- may be one of the best horses on which to bet.
THAT SAID, WALL STREET IS CONCERNED these days by the Pure Digital purchase and by a March 16 announcement that the company will start selling servers this year in competition with Hewlett-Packard (HPQ) and IBM (IBM), which resell Cisco routers and switches.
At first blush, both initiatives offer growth at the expense of profit. Cisco's gross profit was 64.5% of sales last year; servers have gross profit margins of only 20%, and the margin on consumer gadgets is even less. Moreover, Cisco stands to lose an estimated $2 billion annually in router sales through partners HP and IBM, analysts estimate.
Chipper: A huge Thursday rally in semiconductor related stocks like Applied Materials lifted the Nasdaq Index to 1656, up 1.9% for the holiday-shortened week.
Upon reflection, however, both deals make good sense. By diversifying beyond routers and switches, Cisco is going where corporate computing is headed. It can't just sell routers and switches anymore; it must provide the network that's inside server computers.
As for Pure Digital, Cisco bought the company not just for the Flip Video device, but to gain access to Pure Digital's design and marketing talent at a time when the technology business increasingly is driven by consumers.
"It is really all about creating fantastic consumer experiences, with easy-to-use software, and that is what Pure Digital has done," Charles Carmel, Cisco's vice president of corporate development, says.
Adds Invesco Aim's Nelson: "We are inclined to give Cisco the benefit of the doubt" that it can make the deal worthwhile.
Wall Street is beginning to catch up with developments at San Jose, Calif.-based Cisco.
In a note dated April 5, Goldman Sachs analyst Simona Jankowski argued consensus revenue estimates are too low for this year and next. Jankowski believes Cisco is taking share from, among others, Nortel Networks (NT) and HP. Cisco's sales probably will trough in the quarter ending July, she writes.Selling servers and digital-video gadgets represents the biggest departure from business as usual in Cisco's 25-year history. There is reason to think these initiatives will pay off, transforming Cisco into a growth company -- and growth stock -- again.