Is It Time to Believe in Cisco Systems Once Again?

Cisco , the planet's biggest manufacturer of networking gear, recently declared its results for the third quarter and managed to impress the Street at a time when the chips were down for the company. Although Cisco's third-quarter revenue and profit continued to decline, they both managed to stay ahead of market expectations.

However, the real bright spot was its estimate-beating guidance for the current quarter. While Cisco expects its ongoing quarterly revenue to fall by around 1%-3%, profits are anticipated to be in the range of $0.51-$0.53 per share, with analysts expecting less than that on both counts.

With the Street acknowledging the company's efforts through an 8.2% rise in the stock price, the real issue regarding Cisco's future is centered on the question of sustainability. It's time to delve a little deeper into what lies ahead for Cisco.

The not-so-good things first
Cisco's core business of selling network routers and switches has taken a big hit, thanks to a recent trend dubbed "software-defined networking." Already adapted to a large extent by tech behemoths such as Google and Facebook, the concept involves replacing conventional networking hardware with software designed to perform the same functions.

The impact of this was evident during the third quarter, as revenue from Cisco's routing division continued to decline by 10% -- more or less unchanged as compared to an 11% fall during the prior period. Switching systems, the company's most important division, also saw revenue decline by 6%, although this was much better that the 12% fall during the earlier quarter.

One of Cisco's biggest pain points, however, continued to be its dismal performance in fast-growing emerging markets, as highlighted by a 13% fall in revenue derived from those regions. The company is already facing stiff competition from local network equipment makers such as Huawei Technology in China, the biggest market in this segment. Others, such as Juniper Networks, that use relatively less costly components to make routing equipment also present a big headache for the company.

Anything good about it?
Developed markets such as the U.S. provided a much-needed respite for Cisco during the quarter, as order bookings in the region rose by a healthy 7%, based on increased demand for networking equipment from service providers catering to mobile-data traffic. Cisco's book-to-bill ratio was greater than 1 during the quarter, providing further evidence of its healthy order bookings. This is an important and closely watched metric that is a measurement of a company's new order bookings in relation to its current revenue.

The company also claimed a strong pipeline of orders placed by around 1,000 new customers for its newly launched Nexus 9000 line of routers, something that should boost the fortunes of its routing division by the end of this year.

The other newbies
Apart from its core business of selling networking equipment, two other important recent aspects of Cisco's overall business plans for the future include the Internet of Things -- or the Internet of Everything, as the company prefers to call it -- and cloud computing.

The former is a favorite area of interest for CEO John Chambers and involves the concept of adding computer-oriented artificial intelligence to common everyday objects such as microwaves and refrigerators. Cisco believes the market will be worth a whopping $19 trillion by the year 2020, and it plans to invest in a number of start-up companies built around this concept.

The other aspect involves cloud computing, an area where the company has committed itself to spending $1 billion over a two-year period to set up data centers to run its cloud-based operations under the broad category of Cisco Cloud Services. The idea is to target and Google, two of the biggest companies offering such services.

The burgeoning competition
Cisco is not alone in its efforts to grab a larger share of the cloud services market. Industry peer Hewlett-Packard also recently disclosed plans to invest a similar amount as part of a two-year initiative to develop its own cloud-computing offerings. The company plans to offer these under the "HP Helion" brand name, and it has plans to open 20 data centers over an 18-month period.

IBM , which recently sold off its less profitable low-end server operations to Chinese computing giant Lenovo, also outlined ambitious plans to invest $1.2 billion to build as many as 40 cloud services-based data centers spread across 15 countries by year's end.

Foolish final thoughts
Cisco's failure to outline a clear strategy to address its dismal performance in emerging markets should be a distinct point of concern for believers in the company's future potential. But then, with around $50 billion worth of cash in its kitty, the company looks pretty well-placed to expand its current lines of business and also spend more on research and development of newer product lines like the Nexus 9000 routers.

While Cisco's present situation still does not provide enough confidence to buy now, it might pay to keep a close watch on the direction that it's headed by the end of this year.

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Subhadeep Ghose has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines. 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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