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Cisco Systems – Earning analysis

, July 1, 2013, 0 Comments

Cisco designs, manufactures, and sells Internet Protocol (“IP”) based networking and other products related to the communications and information technology (“IT”) industry and provide services associated with these products and their use. Cisco also provides broad line of products for transporting data, voice, and video within buildings, across campuses, and around the world. Various products offered by cisco as switching, NGN routing, collaboration portfolio integrating voice, video, data and mobile applications on fixed and mobile networks, security, wireless, data center, other products comprising linksys home networking products, certain emerging technologies, and other networking products. In addition product offerings, cisco provides a broad range of service offerings, including technical support services and advanced services.

One of the key strategies involve acquisitions, investments and alliances in companies which directly compete with cisco or are instrumental in increasing its technical capability, customer base and market share. Since Mid-year 1993, Cisco has acquired 160 companies of various sizes majority of them being based in US. Spending in Research and Development is to the magnitude of 5 billion per year as the industry in which cisco competes is subject to rapid technological developments, evolving standards, changes in customer requirements, and new product introductions and enhancements.

Five foundational priorities for Cisco to continue expanding share of customers’ information technology spending are

• Leadership in our core business (routing, switching, and associated services) which includes comprehensive security and mobility solutions
• Collaboration
• Data center virtualization and cloud
• Video
• Architectures for business transformation

Summary and Investment Conclusion:
• Cisco designs and manufactures internet based networking and other related products. Firm acquires many small players in market which are strategic fit to the business.  In FY 2012, three companies were acquired for a total of USD 7.2 billion plus. In FY 2013, Cisco had acquired three companies by April 2013.

• Due to acquisitions, goodwill on balance sheet keeps growing. As of FY 2012 it is 25.51% per employee.

• Revenue increased by 6.58% in FY 2012. Products being higher percentage of revenue, profit from products (4.51%) was less than half compared to services (12%).

• Total asset turnover has declined causing return on equity to deter.

• Accruals are low in FY2012 indicating good quality earnings, however have varied hugely in past due to varying short term debts, funds from investments.

• Firm has debt schedule of USD 16 billion in next 5 years.

• In light of industry life cycle, products heavily dependent on innovation, competitors sometimes competing on price, current market conditions investment in this industry is moderately risky. Fair value per share weighted across various scenarios is USD 24.99.

Porter’s five forces analysis for Cisco Systems, Inc.
Barrier to entry: Competitors compete across many product lines and some primarily focus on in specified product area. Barriers to entry are relatively low, and new ventures to create products that compete with cisco products are regularly formed.

Substitute: While products made by Cisco are not easily substitutable, products itself reach the end of their life cycle for number of reasons. Market demands, technology innovation or the products simply mature over time and are easily replaced by functionally richer technology. Substitute of products is moderate to low, with an exception of disruptive technology having potential to completely substitute the products.

Supplier: Supplier power is low as Cisco diversifies its supply base across many vendors. More importantly there is ample evidence that Cisco might acquire the supplier if the company poses a threat.

Buyer: Buyer power is moderate as the products from various firms might not differ extensively, with an exception of any disruptive technology having potential to oversee benefits against cost of switching.

Industry competition: Industry competition is highly supported by price competition amongst firms. Acquisitions supplement the presence of strong rivalry.

• Heavy dependence of product innovation and enhancements to existing products. Inventory management and obsolete product handling.

• Business dependent on continued growth of internet and internet based systems.

• Acquire competitors at the right time which could dampen market share. Industry consolidation amongst peers.

• Acquired companies may or may not produce desired results. Goodwill per employee has increased from 11.89% to 25.51% from FY2003 too FY2012.

• Increased cash conversion cycle due to deteriorating market conditions.

Financial statement key analysis
Revenue Build up and profit contribution

Revenue has increased since last year by 6.58%. Profit for product looks stagnated at 4.51% whereas profit from services were impressive 12%. Switches contributed 2.5% and routers just below 3%. Other product category eroded the profits by 20.33% balanced by new products which contributed 13.51% growth in profit.

Dupont Analysis
Return on Equity is adjusted for non‐operating gains (losses). Over the last six years, the ROE has decreased below 20%. Though revenue on an absolute measure has increased by 6.58% in FY2012, relative to assets owned it shows a steep decline.

Accruals Ratio
The low accrual rate in FY2012 indicates good earning quality; however the variability in past years is a concern. Long term debt has increased and short debt has varied causes variations in balance sheet accruals. Variability in investing cash flow  in FY2009 , 2010 has caused the accrual ratio to differ in the past.

ROE,  TAO  and  per  employee  good  will,  revenue
Return on  equity  has  shrunk  over  years  along  with  the total  asset  turn  over.  Series  of  acquisitions  has  increased goodwill  per  employee  by  close  to  13%.


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