EUR 850.00 For Business Accounts Only

Morningstar | Cisco Readies for Cloud Networking Era With Software and Services Focus; Raising FVE to $41

After taking a renewed look at Cisco Systems, we are raising our fair value estimate to $41 per share from $40 and maintaining our narrow moat and stable moat trend ratings. In our view, shares are slightly overvalued, but Cisco deserves attention for its shareholder capital return policy, ability to generate free cash flow, and our expectation that Cisco will execute on its growth strategy.

In our view, Cisco's expansive and sticky installation base provides switching costs in the enterprise and campus markets. We assess that Cisco's strategic shift toward growing software and services will help maintain its leadership position in networking as customers adopt hybrid-cloud networking models. In our view, previous market share losses suffered in hyperscale cloud and service provider installations will be offset by software-defined networking suites, hybrid-cloud offerings, and solutions that cover the network edge to edge.

Cisco remains a networking equipment behemoth and continues to execute on its strategic focuses of selling software and services to supplement its hardware products. Software and services were 43% of fiscal 2017 revenue, and the company's goal is to have those revenue streams make up at least half of fiscal 2020 sales. We assess Cisco's plan as the correct direction for sustainable growth and believe the firm will meet or exceed its software and services revenue goal. Through its organic developments and acquisitions, Cisco's portfolio remains appealing to customers migrating toward software and cloud-based solutions.

The company is the dominant supplier of switches, routers, firewalls and complementary networking products. Cisco's products are mission-critical for network performance, stability, and security. As networking teams are adopting cloud solutions, Cisco is proliferating software, analytics, wireless, and security offerings to satisfy nascent trends. With its extensive product portfolio, we see Cisco as the only one-stop-shop networking vendor. We believe Cisco's vast existing installation base and budding product offerings, like network monitoring and analytics, keep Cisco as an industry leader.

Despite Cisco's commanding position in switches and routers, IT professionals are increasingly shifting computer workloads to the cloud, in turn buying less data center hardware from firms like Cisco. Cisco is rebounding with its most successful switching product launch in history, the Catalyst 9000. The Cat 9k has a subscription-only sales model, sold in three-, five-, or seven-year increments. Alongside the switch, software packages containing different levels of analytics and security must be purchased. We are encouraged that Cisco is rolling this sales model to more product lines and that most customers are signing up for the most expensive tier that includes advanced analytics and security. We also see positive momentum being gained by Cisco's strategic adjustment to cooperatively develop products with key customers and its willingness to disaggregate software from hardware as more large-scale customers move toward software-only consumption.

Over the next two fiscal years, the company should exceed its target of receiving at least 50% of revenue from software and services in fiscal 2020 as compared with fiscal 2017's 43%. We believe the company's intent-based networking, analytics, and Internet of Things software in conjunction with market adoption of cloud solutions and software-defined networking catalyzes Cisco's software and services growth. The software focus will supplement hardware losses from white-box or public cloud adoption while encouraging customers to choose Cisco for an optimized network with a single vendor for analytics, security, and hardware.

In our view, by being the innovator or an early follower of new networking trends, Cisco has poised itself for continued growth as some business units experience rapid growth while other segments fight against headwinds. Though relatively small businesses for Cisco, we forecast 46%, 14%, and 7% CAGRs through fiscal 2022 for the analytics, security, and wireless business groups, respectively. Those growing business units should keep Cisco's growth net positive even with an expected decline in routing coupled with soft outlooks in the data center and switching businesses. Cisco's announced intention to acquire July Systems, a firm focused on user behavior analytics through cloud and location services, further reinforces Cisco's intention to move toward the network edge and extract value from data analytics.