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Cisco and Competition

Posted on Wednesday, May 7th 2008

In the Online Video Beneficiaries series, I have written extensively on Cisco and other networking players (or dwarfs?) and hinted at consolidation among the dwarfs to take on the giant. In this post, we will look at Cisco’s earnings report and also look at 3Com and Juniper and assess their strategy and progress with Cisco.

Yesterday, Cisco reported its third quarter results that beat Wall Street estimates. However, its revenue guidance remained conservative like the last quarter with revenue growth of 9 to 10% but it remained confident of returning to its long-term growth target of 12 to 17%. Its shares went up 1.1%, or 29 cents, to $26.62 in after-hours trading. Today’s range has been $25.65 – $27.00.

Net sales were up 10.4% to $9.8 billion but GAAP net income was down 5.4% to $1.8 billion or $0.29 per share. Excluding acquisition-related charge of $246 million, or $0.04 per share and other charges, non-GAAP net income was down 3.3% to $2.3 billion or $0.38 per share. Analyst estimates were revenue of $9.75 billion and earnings of $0.36 per share. It repurchased 83 million shares of its common stock worth $2 billion.

Segment-wise, revenue from Routers went up 14% y-o-y to $2 billion driven by strong 26% growth in high end routers. Switches revenue was up by 3% y-o-y to $3.2 billion driven by growth in 6 switching portfolio. Cisco continued to benefit from the online video trend and Advanced Technologies revenue was up 17% y-o-y to $2.4 billion. Unified communications including WebEx grew approximately 45% and WebEx grew 20%. It has shipped more than 500 TelePresence units (since its launch in 2006) and recently broke into the Asian market with Tata Communications, its first Asian service provider.

Total services revenue was up 15% y-o-y to $1.6 billion, due to strong growth worldwide.
Region-wise, revenue grew 5% y-o-y and declined 2.8% q-o-q in North America to $5.1 billion. Europe grew 14% y-o-y and 6% q-o-q to $2.1 billion. Due to revenue recognition of previously deferred revenue and more sales, emerging markets grew 44% y-o-y but declined 10% q-o-q to $1.1 billion. Asia Pacific grew y-o-y in the high teens with India growing in the mid teens, China in the 30’s, and Japan in mid 20s. Order growth in emerging markets was 10% y-o-y vs. 24% in Q2 showing signs of weakness that I have hinted in earlier posts available here and here.

Cisco announced its first acquisition in the year of its subsidiary, data-center technology vendor Nuova Systems. It previously held 80% in the company and has now bought the remaining 20%.

Cisco also announced new public-private collaborative programs in China as part of its $16 billion multi-year innovation and sustainability initiative. Looks like it is seriously considering taking on H3C or 3Com in China now that the Bain-3Com deal has been called off. H3C is a big force to reckon in China. It is the leader in stackable (fixed port) switching ports, mid-range router shipments, and Layer 2 unmanaged (fixed port) switching revenue.

In March, 3Com released its Q3 2008 results. Revenue increased 4% y-o-y to $336.4 million. Net loss was $7.8 million, or $0.02 per share, up 62.5% mainly due to a $6.1 million non-cash deferred tax liability provision that is likely to be reversed in the coming quarters. Non GAAP net income was net income was $34.2 million, or $0.08 per diluted share, compared with net income of $11.0 million, or $0.03 per diluted share.

Segment-wise, H3C had revenue of $212.6 million, a 9% growth mainly driven by increased direct sales in China (helped by its acquisition of 49% from Huawei last year) and appreciation of Renminbi, offset partially by reduced OEM sales to Huawei.

Data and Voice Business Unit (DVBU) revenue was up 1.7% y-o-y to $134.6 million driven by increased sales in EMEA and LAT, offset by decreased sales of connectivity products and softness in North America.

Tipping Point revenue decreased 3.7% to $23.6 million mainly due to one-time charges related to deferral of Federal Government sales. Revenue from networking products which accounts for 83% of the total revenue, increased 7.9% to $279.8 million.

Region-wise, China revenues went up 10% to $169.9 million (51% of revenue). EMEA revenues went up 15% to $75.4 million, North America decreased 27% to $42.9 million, Latin America went up 18% to $21.2 million and Asia-Pacific rim excluding China revenues were flat at $27.0 million.

Following the collapse of the Bain Capital transaction, 3Com’s restructuring efforts have been delayed. It is now reducing its R&D costs by $15 million annually through integration of R&D functions and capitalizing on the low-cost, high quality talent in India and China. It also expects to further reduce costs in R&D, supply chain, and G&A.

For Q4, 3Com expects revenues between $310 and $315 million with H3C revenues in the $180 million to $185 million range. Non GAAP operating profits are expected between $18 and $25 million range and earnings per share between $0.04 and $0.07. Direct sales in China are expected to grow more than 20% and sales to Huawei 25% lower. DVBU should grow modestly q-o-q and Tipping Point sales should show double-digit y-o-y growth.

3Com recently got a new CEO, Robert Mao who will be based in China replacing Edgar Masri. 3Com, also has hired Ronald Sege as Chief Operating Officer for US operations. It is trading around a dismal $2.5, a far cry from its share price around $100 in 2000. Its market cap is around $1 billion and it hit a 52-week low of $1.76 on March 20.

As I have said before, I really liked 3Com’s plans of taking advantage of its China cost-structure and going after Emerging Markets where Cisco’s fatty cost-structure hinders them. Going forward, even thought 3Com’s Bain transaction has fallen through, that strategy should not change. And the fact that they have assigned Bob Mao as the CEO to be based in China is a good validation. Everything will depend now on execution.

Chart for 3Com Corporation (COMS)

Coming to Juniper (JNPR), it released its Q1 results on April 24. Revenue increased 31% to $822.9 million. GAAP net income was $110.4 million or $0.20 per diluted share, and non-GAAP net income was $149.5 million or $0.27 per diluted share. Analysts had estimated revenue of $815.6 million and profit of $0.25. Unlike Cisco, its sales were not affected by the woes of the US economy. Americas accounted for 51% of sales, up from 48% in Q4. Its shares closed 1.4% and were up 3% in recent after-hours trading.

Segment-wise, infrastructure segment grew 35% to $621.8 million. Service Layer Technologies (SLT) revenues grew 21% to $201.1 million led by good performance from by SSL, CPN and SSG products. Service provider sales were up 35% y-o-y and 8% q-o-q and accounted for 74% of sales led by good growth in the Americas and APAC. Enterprise sales were up 21% driven by good growth from EMEA and APAC.

Early in the quarter, Juniper expanded its portfolio with the introduction of EX series, its high end enterprise switches. According to research company Dell’Oro Group, it had 16% of the $11.6 billion worldwide router market in 2007, compared with Cisco’s 65%. In the $4.2 billion enterprise-router market, Cisco has 82% and Juniper 5%. In the $4.7 billion service-provider edge-router market, market share for Cisco is 54% and Juniper 18%. In the $2.7 billion service-provider core-router market, Cisco has 55% and Juniper 30%.

For Q2, Juniper expects revenues between $845 and $855 million. Its stock is trading around $28 with a market cap of around $14.7 billion. Cisco is trading around $26 with a market cap of around $154 billion. While Cisco hit a52-week low in February, Juniper was unfazed by the weak economy. Though, Cisco might be a giant with huge revenues and market share, Juniper is certainly a favorite on Wall Street right now.

Chart for Juniper Networks, Inc. (JNPR)

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