What Should Cisco Buy Next?

What Should Cisco Buy Next?

Cisco takes pride in having a presence in all areas where an Internet connection is possible. But, in recent quarters, it appears as though competition is intensifying in two key businesses: the server and router segment, and cloud computing/cyber security. As a result, Cisco should consider major moves to solidify its place as a long-term tech leader, which could then drive its stock higher.

Becoming an acquisitive company
Cisco is a large company with nearly $50 billion in annual sales. Approximately half of its business is derived from servers and routers, but with a rise in software-as-a-service and big data, Cisco has made aggressive attempts to build its software business.

In recent years, Cisco has been one of the most acquisitive tech companies in the market, spending more than $10 billion in the last three years, with nine of the last 10 acquisitions being software companies. In the meantime, Cisco has struggled with slow growth in Japan and China, and in its last quarter saw product revenue rise just 1% year over year.

The company's service revenue was marginally positive in the last quarter, seeing growth of 4%, but far below the rate at which many of the company's peers are growing. With that said, Cisco is doing all it can to acquire growth, and with $48 billion in cash, two companies in particular might help boost investor sentiment.

Acquiring low-end growth
The largest problem involves servers and routers. As stated, it's the largest chunk of sales, but Cisco faces intense pricing competition, especially in the low-end edge router space.

During the company's fiscal second-quarter report, Cisco reported that it lost market share in the low-end edge router space. This is an area that Cisco has controlled for many years, but is likely losing share to Juniper Networks .

Juniper, along with Hewlett-Packard, is Cisco's biggest competitor in the server and router business. While HP is more diversified, Juniper operates more in the enterprise business (security) and low-end router space. In Juniper's last quarter, it saw double-digit quarter-over-quarter growth in its carrier low-end routers.

The router business has been very strong for Juniper, a multibillion dollar segment. Seeing as how Cisco is in the business of acquiring growth, it might view Juniper's double-digit performance as a lucrative opportunity, especially without its software segment. With Juniper trading at 2.2 times sales, it appears that Cisco could acquire the business for a fair value price.

The growth of security
If Cisco were to make a splash by acquiring Juniper, it would obtain a declining security business, which might have good synergies with Cisco's own security segment. However, Cisco is not losing market share to Juniper in this segment. Instead, tech giant Oracle and smaller rival Palo Alto Networks are hindering Cisco's performance.

In cloud computing and cyber security, Cisco used to have pricing power, but due to the rise of new competitors, Cisco no longer has the pricing freedom that it once had. Thus, Palo Alto looks like an attractive acquisition target, a company that's really firing on all cylinders.

Palo Alto offers a best-in-class network security platform that allows enterprises, service providers, and government entities to secure their networks. During the company's most-recent quarter, it saw revenue growth of 49% year over year.

Unlike servers and routers, the goal of Palo Alto's business is to gain long-term subscriptions, which then translates into future sales. In its last quarter, deferred revenue (i.e., security service subscriptions) grew 74% year-over-year to $279 million, which was 12% better than the three months prior.

For Cisco, it saw service provider orders fall 13% year over year, and does not expect a pick-up in demand in the near future. Thus, Palo Alto, with its accelerated growth, would be a nice addition to Cisco's business. While Palo Alto is expensive at nine times sales, Cisco could likely scale up growth at a quicker rate.

Final thoughts
Cisco has encountered a number of problems in the last three years, much of which can be traced to macro issues. However, Cisco does have issues it can control, such as losing market share to both Juniper and Palo Alto.

An acquisition of either or both might change sentiment toward Cisco stock, pushing it higher. If not, investors have to like what both Juniper and Palo Alto are doing in each industry, thus meaning that both will be fine with or without Cisco. However, if Cisco keeps losing market share in major segments, it might soon experience even more downside pressure.

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The article What Should Cisco Buy Next? originally appeared on Fool.com.

Fool freelancer Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of 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.

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Originally published