Hang-Tough Time for Cisco

Can Cisco Systems Chief Executive John Chambers still turn the networking giant around?

That's the question on the minds of many tech investors in the wake of yet another disappointing quarter. On top of mediocre earnings, cisco router Chambers continued to lower expectations. Increased competition from Juniper Networks (ticker: JNPR; see "Juniper: Emerging Network Star"), Hewlett-Packard (HPQ) and China's Huawei (002502.China) is taking its toll. But so are internal organizational issues as well as big-picture strategic quandaries, such as how to reposition the company during the current sea-change in enterprise computing.

It's tough to bet against Chambers, who has been at the helm of Cisco (CSCO) for 16 of its 26 years. He is the supersalesman who directed the company through the period of hypergrowth driven by the historic build-out of the commercial Internet. And speaking personally, I have to say he is one of the most respected CEOs I've met in my nearly 25 years as a business reporter. His utterances move markets.

That said, Chambers finds himself fighting some of the toughest battles of his career on multiple fronts. In addition to increased competition, Cisco is suffering from talent drain and a lack of clear direction in pursuit of new products and markets. Exhibit A: the recent closure of the Flip digital video device unit.

Late last year, my colleague Michael Santoli argued that if Cisco reached its long-term revenue growth goals of 12% to 17%, shares would rise to 27 ("Ending the Cisco Skid," Dec. 27, 2010). Shares were about 20 at the time. By February, ws-x4624-sfp-e the stock had risen a couple of bucks. But last Friday, after a week of lousy news, shares closed at 16.88.

In the short run, with shares trading a bargain-basement nine times forward earnings, Cisco's stock could reward investors yet again. But when? And will the recovery have staying power? Sterne Agee analyst Shaw Wu, who has a Buy recommendation, says it may take a "few quarters to fix" the problems. But eventually, the bull sees shares surging back to 29 over 12 months.

Cisco blamed reduced government spending and lower margins on newly introduced products for some of its woes. It acknowledged that competition has stiffened. Switch sales were down 9%. Chambers announced $1 billion in cost reductions, including potentially the largest layoff in company history. ws-x45-sup7-e A Cisco spokesman said that recently launched new products will see fatter profit margins over future quarters as they ramp up and gain more scale.

THE GOOD NEWS IS THAT DEMAND for networking gear is growing. The bad news is that the company is suffering from problems that are specific to Cisco, of which some could be systemic and long-term.

In the short term, bulls such as Wu might be right. But over the long haul, Cisco may continue to struggle to find new growth. A recent study by Gartner, the research outfit, entitled "Debunking the myth of the single-vendor network," identifies a huge threat to its core business. ws-x45-sup6l-e Cisco has long told customers that owning a Cisco-only network is more cost efficient, which locked in corporate customers at higher prices. But the study contends that the introduction of a second vendor, such as Juniper or HP, could actually decrease the total cost of ownership of a data network by 15% to 25%.

If that's true, Chambers really has his work cut out for him.