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Many analysts are downgrading Cisco's stock after a hugely successful 2006. Does it deserve it?
January 17, 2007
Wall Street analyst downgrades have helped knocked down shares of Cisco Systems Inc. (Nasdaq: CSCO), with the stock under serious pressure this week.
Cisco shares fell 3 percent on Tuesday and another 4 percent today. Analysts from Prudential Equity Group LLC and Banc of America Securities LLC downgraded the stock this week, and a hedge-fund source said that Merrill Lynch & Co. Inc. analysts had less-than-happy things to say about the stock to clients today, though Light Reading could not confirm whether or not Merrill downgraded it. Merrill Lynch did not return phone calls seeking comment. Cisco shares gained 70 percent in 2006.
"After lagging in 2005, revenue growth slowly caught up with order growth throughout 2006," said Prudential analyst Inder Singh on a conference call yesterday, announcing his downgrade of the stock. "Now sales and orders are growing at the same rate. Clearly, sales can't grow faster than orders, so we see little room for upside."
The reality seems to be that that the market for routing and switch equipment is still growing, but slowing down. In a report titled "We Believe it's as Good as it Gets," Banc of America analysts said Cisco's business has certainly been firing on all cylinders, but that's exactly the problem -- there are no more cylinders. "Market research shows that Cisco's market share has peaked in several of its businesses, particularly the core enterprise switching and IP routing segments," according to the Banc of America report, written by analyst Tim Long.
Cisco has now turned its focus into new consumer markets, which could be poised for growth in 2007. Can Cisco enjoy the same success in this market that it does in its routing and switching business? "The Linksys acquisition is the centerpiece of Cisco's strategy to get into the connected home market. I think this was a smart move that will position them strongly," said Andrew Schmitt, general partner of Nyquist Capital .
But Cisco might be entering a small market with an already daunting roster of participants. Among those seeking entry are Alcatel-Lucent (NYSE: ALU), Apple Inc. (Nasdaq: AAPL), which introduced Apple TV at CES last week, Ericsson AB (Nasdaq: ERIC), Motorola Inc. (NYSE: MOT), and Microsoft Corp. (Nasdaq: MSFT). (See Apple Intros Phone, TV.)
That's a lot of heavy hitters for a market that is currently very small. "The IPTV market was $1 billion in 2006 which is not very big," said Prudential's Singh. "It is growing, but it is still small. Cisco is trying to get into this very crowded market."
Schmitt doesn't see the big names as an obstacle for Cisco, but he agrees that despite whatever success Cisco has, it won't be big enough. "I wouldn't worry about Apple because they don't have a relationship with carriers like Cisco does. However, you have to look at the dollar magnitude of the market."
So Cisco enters 2007 with plenty of skepticism about whether it can live up to expectations. But still, analysts say there's no reason to expect an extended bear market in the stock. "If you have an investment timeframe of 2 to 3 years, then Cisco is a good buy, but they will be treading water for a while," concluded Singh. Cisco will hold its quarterly earnings call on February 6.
— Raymond McConville, Reporter, Light Reading
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