Can Cisco Adapt as Internet Changes?
Cisco Systems, the leading Internet company, last week seemed to embody all the sudden doubts about new technology and the economy.
Cisco stock hit a 52-week low, joining other technology stocks during a miserable week of sinking share prices amid corporate announcements of slowing business.
Analysts are downgrading their opinions on Cisco, which has fallen from $82 a share last March to $27 in Friday’s close. Yet they continue to predict good long-term prospects for the San Jose company, which is expected to reach some $26 billion in revenue this year.
Similar forecasts of short-term pause and long-term growth are issued for other technology companies, from Silicon Valley giants such as Sun Microsystems to relative newcomers like Juniper Networks.
The paradox amid talk of slowdown is that business on the Internet continues to grow rapidly. U.S. companies will invest more than $100 billion in information technology this year, about 9% more than they invested last year.
Cisco is growing, too, even as its chief executive, John Chambers, speaks of the possibility of layoffs. In the first six months of its fiscal year, which ends July 31, the company reported sales and profits almost 60% ahead of last year. In the latest quarter, Cisco’s net income rose 48%, which was slow only in comparison with peak periods of recent years.
And the Internet, as it moves onto fiber optic cables and wireless networks, continues to supplant old phone lines and bring cost savings and productivity gains to industry.
Information technology has already transformed American business, as new Treasury Secretary Paul O’Neill said recently. But, he added, only 20% of the potential has been realized. “There’s a very long way to go in the U.S. economy and the world economy.”
Morgan Stanley, the investment banking firm, adds up the global potential by noting that 33% of the North American population uses the Internet, compared with 23% in Japan, 14% in Europe, 3% in Latin America and only 1% in the rest of Asia.
To understand why such a global growth business can be mysteriously stalled, focus on Cisco, which grew from a small company that made computer networking gear to the largest supplier of computer devices, called routers, that enable information to get where it’s going on the Internet.
Cisco began when two Stanford University professors invented router devices so their computers could communicate across campus. Venture capital investors bought out the professors a few years later, and Cisco’s business grew based on its expertise at linking computers in networks.
It has been led over the last decade by executives trained as salesmen--Chairman John Morgridge, a veteran of Honeywell’s computer operation, and President Chambers, who had worked for IBM and Wang Laboratories.
Cisco succeeded because it didn’t focus solely on technology but concentrated on helping companies use the Internet. IBM had used a similar approach successfully in the early years of the Computer Age: Instead of just selling mainframe computers, IBM helped companies automate their operations.
And rather than spending on its own internal research, Cisco reached out to acquire small companies that were coming up with innovations in Internet communications and computer networking.
Cisco has made more than 60 acquisitions in the last decade, but it prides itself on avoiding redundancy layoffs, a policy that resulted from Chambers’ having had to lay off 5,000 people at a clip when Wang was troubled in the 1980s. Cisco instead stays lean by letting go the bottom 5% of performers each year.
The company’s growth in sales and income was fantastic--sometimes 90% a year. “Their hold on the corporate market allowed them to raise prices on their routers and still get the business,” says Jeffrey Young, author of a new book, “Cisco Unauthorized: Inside the High-Stakes Race to Own the Future” (Forum, 2001)
But now, as Chambers has been saying in meetings with investment analysts, Cisco will have to struggle to grow.
The reason is that the Internet is going from one phase to another. The basic backbone of the network is essentially built out. Wireless systems and optical networks to carry Internet traffic will be the growth areas in the next five years.
Cisco is participating in wireless devices and optical networks. But it does not have the dominant position in those areas that it held in routers. Competitors Nortel Networks, Ciena and Sycamore Networks are stronger.
Another area of growth will be the so-called last mile, carrying broadband Internet into homes, offices and small businesses. But Cisco does not have the same relationships with Internet service providers and telecommunications and cable companies that it has with major corporations, Silicon Valley executives say.
What it adds up to is that Cisco will have to adapt to increased competition. “It will have to do more product development, more in-house research,” says Randall Kruep, a former Cisco executive who is about to become chief executive of Procket Networks, a new company in Internet services.
In Wall Street’s eyes, the more competitive environment means that Cisco’s gains in sales and income won’t come as fast as in recent years. That’s why analysts have been downgrading their opinions of the company’s immediate future.
The company can grow perhaps 20% a year, concedes analyst Christopher Stix of Morgan Stanley, but that is less than the 30% to 50% a year that Chambers continues to forecast.
Yet almost all analysts and executives in Silicon Valley note Cisco’s abilities to form relationships with business customers and to reach out for alliances with other companies.
“They make alliances and call on networks of expertise,” says Mark Stone, chief executive of Narus, a private company that has developed an Internet information service for telecommunications carriers.
As Internet business continues to grow and develop, Cisco’s ability to adapt should keep it one of the great companies of the new era, says venture capitalist Tom Dyal of Redpoint Ventures.
Cisco is like high technology overall--now going through a transition and a pause for breath, but destined to become the world’s most significant business in this decade.
At this time, with stocks falling and gloom rising, we should recall Secretary O’Neill’s judgment that we’re only 20% of the way through this information revolution.
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James Flanigan can be reached at jim.flanigan@latimes.com.
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Which Way Next?
Cisco Systems, the leading supplier of Internet networking systems, has had a decade of extraordinary growth in net income, accompanied by an even more spectacular increase in stock prices. But stock price gains have reversed in recent months even though earnings growth remains rapid.
Cisco’s net income is rising ...
In billions
2000: $3.9 billion
Sources: Company reports, Value Line, Bloomberg News
... but its stock price has slipped.
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Fiscal years Stock price extremes for year* ended July 31 High Low 1991 $0.50 $0.10 1992 1.10 0.40 1993 1.80 1.10 1994 2.30 1.00 1995 5.00 1.80 1996 7.70 3.50 1997 10.10 5.00 1998 24.40 8.60 1999 53.60 22.50 2000 82.00 35.20 8/1/00 68.63 25.13 to 2/22/01 (8/31/00) (2/21/01)
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* Adjusted for splits
