What Cisco's Results Mean to the Tech Market


The market always looks to Cisco Systems' results because they are usually a good indicator of where technology is headed. The latest earnings report proved no different. Cisco discussed a slow but ongoing economic recovery that contains some notable differences in growth rates from various regions. It seems that different geographies and end markets are taking turns to outperform for one period and then disappoint in the next. It looks like the tech markets are set for more uncertainty in the second half.

Cisco reports mixed regional growth...
Cisco's 6% revenue growth in the fourth quarter was in line with its long-term targeted aim of 5% to 7%, so investors could be easily forgiven for thinking that it was just another quarter. However, the underlying story was the relative performance of each region.

Revenue from the Americas grew 7%, and Europe, the Middle East and Africa (EMEA) grew an impressive 12%, but this quarter Asia-Pacific, Japan and China (APJC) actually fell 3%. Moreover, Cisco saw noticeably varied performance within the 8% growth recorded in its emerging markets. India and Mexico recorded double-digit gains, while the Brazil and Russia were flat with China down 6 %.

...and mixed industry growth too
It wasn't just a regional issue. In terms of orders by customer, enterprise declined 2% (with particular weakness in EMEA) although commercial grew 5%, and the global public sector grew 6%. The latter is notable because three quarters saw weakness in the public sector. In addition, service-provider orders grew 6%, and this comes after whole swathes of the tech industry had reported weakness in service-provider spending in the first quarter of 2013.

Furthermore, there was even some significant variability within Cisco's sales. Starting with its core sales, switching had a good quarter as new products were released, but routing had another weak set of results. There was also some bad news with services revenue only growing at 5.6% when Cisco plans for 9% to 11% for the next three-to-five years.

Its core activities of switching, routing, and services typically make up 68% to 69% of Cisco's total sales.

Source: Company accounts

What it all means to the industry
Investors should expect more unpredictability in the tech market. Oracle's (NYSE: ORCL) recent results were also disappointing. In common with Cisco, it cited US and EMEA license growth in line with expectations, but saw weaker conditions in China and Brazil. The variance in emerging market performance is worrying because a lot of tech companies spent last year relying on the BRICs for their growth prospects.

Indeed, International Business Machines (NYSE: IBM) reported an overall revenue decline of 3% in its results in mid-July with growth in the BRICs being flat. IBM's results presaged what Oracle and Cisco would say about regional growth, and it also gave a cautious outlook on Brazil and China. On a more positive note, the one key theme from all three earnings reports is that the US enterprise sector is outperforming.

However, investors need to be cautious over expecting too much from the government sector. Austerity measures and sovereign debt issues are not going away anytime soon, and order growth could continue to be lumpy in future quarters.

What to do with the big three?
Frankly, if you are thinking about investing in any of these three companies, then you need to forget about expecting too much help from the macro-environment. IBM's prospects are about its internal restructuring in order to focus on higher margin sales rather than pure revenue generation. Oracle is managing a shift in its revenue to cloud-based software, while also undergoing a transition to new hardware product systems.

One thing that all three have in common is prodigious cash generation, and they currently trade on historically attractive free cash flow yields.

IBM Free Cash Flow Yield Chart
IBM Free Cash Flow Yield Chart

IBM Free Cash Flow Yield data by YCharts

In Cisco's case, you are looking at business that just generated around $11.7 billion in free cash flow, and has over $33 billion in net cash and investments. These figures represent significant percentages of Cisco's current market cap of $129 billion.

Ultimately, the case for buying Cisco remains the same as before these results. Top-line growth will be hard to generate organically (particularly from its switching and routing sales) but its cash generation and assets mean that it can make acquisitions in its non-core segments.

What Cisco needs to do
Here is a breakout of its core and non-core (collaboration, service provider video, wireless, security and data center) revenue growth.

Source: Company accounts

Cisco's challenge is to carry on making acquisitions in order to generate growth in a slow economic environment. In this way it can also help generate growth in its service sales. As a long-term investment proposition, the stock remains compelling, but just be prepared for some short-term disappointments along the way. Global economic growth remains slow and patchy.

The tech world has been thrown into chaos as the biggest titans invade one another's turf. At stake is the future of a trillion-dollar revolution: mobile. To find out which of these giants is set to dominate the next decade, we've created a free report called "Who Will Win the War Between the 5 Biggest Tech Stocks?" Inside, you'll find out which companies are set to dominate, and we'll give in-the-know investors an edge. To grab a copy of this report, simply click here -- it's free!

The article What Cisco's Results Mean to the Tech Market originally appeared on Fool.com.

Lee Samaha has a position in Oracle. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Originally published