Data Center, Cloud & Campus Networking Equipment + Cisco Beats
by Patrick Seitz of IBD (edited by Alan J Weissberger)
AI and machine learning have crept into the computer networking gear business as hardware vendors look to add more smarts to their routers and switches to help customers better manage data traffic and solve problems.
Cisco, Arista, Netgear and Extreme build a range of wired and wireless network switches and routers for moving data.
“The overall business is pretty healthy,” IDC analyst Rohit Mehra told Investor’s Business Daily.
Spending on Ethernet switches alone is expected to rise 3% to $26.3 billion this year, he said.
Business campus and enterprise deployments are the largest subsegment, accounting for 57% of Ethernet switch spending in 2016, the most recent year for which research firm IDC has full-year data. Data centers accounted for the remaining 43% of spending.
Cisco is by far the largest name in the industry, with a market capitalization of over $200 billion. At a fraction of that size, Arista is next in line, with a market cap near $20 billion.
While Cisco has a full portfolio of networking products across customer segments, Arista Networks is focused today on data center customers.
On Wednesday, investment bank Goldman Sachs initiated coverage of Cisco and Arista with buy ratings and Juniper at neutral. The report noted that enterprise spending intentions for networking gear are at their highest levels since 2007.
“Almost two-thirds of respondents indicated that they expect to increase networking spend in 2018, with only 6% expecting a decrease,” Goldman analyst Rod Hall said in the report.
Arista Networks Targets High-Speed Cloud Data Centers:
Arista has high exposure to the hyperscale data center side of the market, which is expected to accelerate slightly to 29% capital-expenditure growth this year, Hall said.
“We are modeling for revenue upside (at Arista) from consensus, as cloud capex looks set to accelerate again in 2018,” he said. “Arista has established itself as the dominant vendor of high-speed data center networking solutions, with nearly 25% share of 100G data center switches.”
Other Network Equipment Vendors:
Juniper Networks has been hurt by large data-center customers buying more commodity networking hardware from so-called white-box vendors, analysts say.
Commodity networking hardware from ODMs/white box vendors uses merchant silicon from semiconductor firms such as Broadcom, Cavium, and Mellanox Technologies rather than purpose-built chips called application-specific integrated circuits (ASICs) from traditional network gear makers like Cisco and Juniper.
Networking gear vendors have avoided the commoditization price trap partly by placing greater emphasis on software and services.
Because of surging data traffic, network administrators need more tools to help them solve bottlenecks, security issues and other concerns.
Cisco (see Update below) has been a laggard in providing predictive analytics and high-level network monitoring and management capabilities, which created opportunities for a host of companies to step in and fill the gap.
But in late January, Cisco announced initiatives to provide more automation and network management capabilities to its product offerings. It introduced tools designed to help information technology teams become more proactive rather than reactive to problems.
Cisco said IT workers today spend 43% of their time troubleshooting. Software innovations should make IT operations more automated, proactive and agile, the company says.
“There’s more of a realization at Cisco that network monitoring, analytics and visibility is key to delivering automation,” IDC’s Mehra said. “If you don’t build automation into your network systems, you’re not going to be there as the market for IoT (Internet of Things) explodes and as cloud continues to gain more affinity in the enterprise.”
Mergers and acquisitions could play a role in the networking gear space this year, especially with cash-rich Cisco. Cisco could make a meaningful acquisition in 2018, Barclays analyst Mark Moskowitz said in a Jan. 17th report.
“We think CEO Chuck Robbins could make a larger, synergistic acquisition (i.e., north of $5 billion to $7 billion) – something that bolsters the company’s cloud, software, security or services presence on day one,” he said.
On Feb. 2nd, Cisco completed its acquisition of BroadSoft for $1.9 billion. BroadSoft adds cloud calling and contact center solutions to Cisco’s calling, meetings, messaging, customer care, hardware endpoints and services portfolio.
Meanwhile, Arista has been a thorn in the side of Cisco’s core networking business, but could become a bigger threat, Moskowitz said.
“If Arista is able to penetrate the enterprise vertical and also gain traction with its routing foray, the headline and fundamental risks (for Cisco) could start to become more meaningful,” he said.
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Update – Cisco Fiscal 2nd Quarter Earnings Report:
Cisco today (February 14, 2018) reported a fiscal second-quarter loss of $8.78 billion, or $1.78 a share, compared with net income of $2.35 billion, or 47 cents a share, in the year-ago period. Adjusted earnings, excluding $11.1 billion in charges from the U.S. tax overhaul, were 63 cents a share. Of the 26 analysts surveyed by FactSet, Cisco on average was expected to post adjusted earnings of 59 cents a share; the company had forecast 58 cents to 60 cents a share.
Revenue rose 2.6% to $11.89 billion from $11.58 billion in the year-ago period, breaking a streak of six straight quarters of year-over-year revenue declines. Wall Street had expected revenue of $11.81 billion, according to 23 analysts polled by FactSet. Cisco had predicted revenue of $11.7 billion to $11.93 billion.
- Product revenue, which makes up 73% of the top line, increased 2.6%.
- Services revenue rose 2.9% to $3.18 billion, while analysts had expected a 0.9% rise to $3.13 billion. Security revenue, on the other hand, rose 6% to $558 million, while Wall Street had expected a 10% gain to $582.8 million.
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Repatriation of overseas cash, mostly to pay for share buybacks and dividends:
Cisco said it would repatriate $67 billion of its foreign cash holdings to the U.S. this quarter, in one of the largest repatriation plans yet revealed. The company plans to spend much of the newly repatriated cash on share buybacks and dividends, it said Wednesday while reporting earnings, amounting to about $44 billion over the next two years. At the end of the quarter, Cisco had $73.7 billion of cash and equivalents, with the vast majority held outside the U.S. Under the new tax law, the company will be able to access its money at a significantly lower rate than was previously required.
Critics of the U.S. tax law have said increases in share repurchases and dividends show money saved from the law is going to shareholders instead of being invested in new U.S. jobs, infrastructure, research and development, and related areas.
The focus on stock buybacks and an increased dividend suggests Cisco isn’t likely to use the cash on a major acquisition, said RBC Capital Markets analyst Mitch Steves (that contradicts the IBD story above). Instead, he expects Cisco to focus on smaller deals, perhaps in a range of $1 billion to $10 billion.
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Since taking the helm of Cisco, Chief Executive Chuck Robbins has focused on subscriptions, common in the software industry but more difficult for a hardware company. That kind of transition can have a negative effect on revenue in the short term, as less of the sale is recognized up front with the rest deferred to later quarters, which Cisco has seen in the past couple of years.
Cisco introduced a new switching family called the Catalyst 9000, a software-centric switch that is delivered as a service with subscription fees and long-term contracts, last June. While previously, a sale of a switch — Cisco’s biggest business — would have been recognized in full up front, Chief Financial Officer Kelly Kramer explained that a healthy portion of that sale is now considered to be for software support and recognized over the length of the contract.
“Of total product revenue, 13% of product revenue is recurring,” Kramer said; at the beginning of Cisco’s fiscal 2015, recurring revenue was about 6% of total revenue, she said.
“The Catalyst 9000 is our fastest ramping product in our history,” Robbins crowed on a conference call.
Kramer largely echoed Robbins’s positive tone in a later interview, while avoiding any grand pronouncements. When asked whether the company’s transition was at an inflection point, she said, ‘I am always hesitant to call any inflection, but I am not surprised about the improvement. Overall, we feel very, very good about our portfolio, this is where we have been focused for a long time.”
Robbins has focused on software as a path, making big-money acquisitions like AppDynamics and BroadSoft, and analysts were curious in Wednesday’s conference call about what may be next for the acquisitive company. Company executives said they plan to bring back all of Cisco’s cash that is outside the U.S. by the end of this quarter under the new tax laws that are now taking hold.
After recognizing an $11.1 billion charge largely from repatriation in Wednesday’s report, Cisco will have many billions of dollars to play with, even after adding $25 billion to its stock-repurchase authorization and increasing its dividend 14% Wednesday.
“We are seeing the benefits of the strategy we started executing on 10 quarters ago,” Kramer said. “We are seeing the benefits as we shift the business model and you are seeing it translate through fantastic financials.
https://investor.cisco.com/investor-relations/news-and-events/events-and-presentations/default.aspx
https://seekingalpha.com/article/4146882-cisco-systems-csco-q2-2018-results-earnings-call-transcript
https://investor.cisco.com/investor-relations/financial-information/Financial-Results/default.aspx
https://www.wsj.com/articles/cisco-returns-to-growth-after-two-year-sales-slump-1518645580
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