Editor’s note: Cisco’s latest quarterly financial results demonstrate its increasingly successful adaptation to next-generation IT architectures under new CEO Chuck Robbins, writes Technology Business Research Analyst Krista Macomber.
HAMPTON, N.H. – Cisco (Nasdaq: CSCO) had plenty of bright spots in its CY3Q15 earnings that directly reflect its extension from high-end networking hardware into critical growth markets such as hybrid cloud.
Total revenue rose 3.6% year-to-year to $12.7 billion, with product revenues expanding 4% year-to-year to $9.8 billion. Notably, Cisco’s Data Center, Collaboration and Switching segments rose 24%, 17% and 5%, respectively, during the same time period. These results point to Cisco’s success in aligning core and newer businesses with customers’ transformation to converged and cloud-based data centers. In fact, CEO Chuck Robbins stated he expects Cisco to hit an inflection point between traditional and next-generation models in its core switching business over the next year.
Furthermore, Cisco’s operating margin rose a vast 520 basis points year-to-year to 24.3%, supported by cost of goods sold and operating expense efficiencies despite closing three acquisitions and announcing three strategic, high-profile alliances. TBR believes Robbins’ focus on business agility and portfolio discipline during his first full quarter as CEO already began to pay dividends for Cisco, with the gross margin compare during 3Q15 partially supported by the summer 2015 divestiture of Cisco’s set-top box business.
However, Cisco is not immune to a highly competitive IT infrastructure marketplace, with routing revenue declines of 8% year-to-year and services revenue growth of just 1% year-to-year. These segments were impacted in part by a lapse in payment cycles from large telecom customers, but also from heightened competition from Alcatel-Lucent — spurring Cisco’s alliance with Ericsson, announced just days prior to its 3Q15 earnings release. However, deferred services revenues grew a promising 7% year-to-year, indicating a pipeline to large multiyear deals focused on network transformation.
Similarly, security revenues grew below the industry average at 7% year-to-year, but deferred revenues rose 31%, indicating that Cisco is incrementally transitioning to next-generation products such as advanced malware protection. Cisco’s key to beating its light guidance for 4Q15 and securing long-term growth is to continue accelerating its monetization of newer portfolio investments, including subscription-oriented offerings such as Meraki, and securing its standing as an enabler of IT and business transformation to customers.
Cisco partners with Ericsson in a landmark move to accelerate its digitization and SDN initiatives
Cisco partnered with Ericsson on Nov. 9 to enable end-to-end networking, cloud, mobility, management and services solutions for enterprises and service providers. This joint venture could significantly alter the information and communications technology market segments, but whether this happens is far from certain. With a history of intense competition between the two firms, there are many financial, organizational and cultural issues that could mitigate the value of the initiative. Critical to the success will be a virtual structure wherein the partnership value supersedes traditional competitive behavior. This will happen only with the commitment of business unit and market unit executives and well-defined rules of engagement with equitable compensation plans.
Most notably, Cisco gains additional access to Ericsson’s service provider customer base and comparatively stronger systems integration, and managed and consulting services capabilities. Ericsson will resell Cisco’s servers and routers in service providers’ environments. Additionally, Ericsson’s services capabilities round out a critical gap in Cisco’s ability to help customers transform to more converged, cloud-enabled, mobile- and IoT-focused network environments.
Traction of joint solutions will begin among service provider customers but will increasingly trickle into enterprise environments following concept validation. Validation is critical as Cisco seeks to accelerate monetization of portfolio investments in areas such as software-defined networking (SDN).
TBR views the alliance as highly complementary, but we note recent competing efforts from Cisco and Ericsson around hyperscale hardware, which is becoming increasingly attractive to large service providers and other large customers outside of Tier 1 cloud service providers. Because Cisco and Ericsson are nascent players in a rapidly growing market, they will need to quickly rationalize their efforts and sharpen go-to-market execution within the alliance, particularly in the face of established competition from Dell, emerging competition from HP and expected competition from ODMs as they expand beyond their cloud roots.
Cisco evaluates its next steps to addressing evolving security pain points and storage architectures
In addition to increasing its number of strategic partnerships, Cisco continues to speed innovation and invest in tuck-in acquisitions to round out its capabilities in strategic growth areas including cloud, security and analytics. Cisco announced four acquisitions in the past 90 days alone and a 25% increase in major new product introductions over the past six months, but gaps remain including around security information and event management (SIEM), software-defined storage and hyperconverged platforms.
Customers are grappling with network hardware and application security during their shift to mobile computing and cloud-based IT delivery. They seek to eliminate the cost and complexity inherent in traditional storage models. For its part, Cisco is struggling against volatile security revenue performance, and Dell’s planned acquisition of EMC could stress relationships with important storage and converged systems alliance partners.
When asked pointedly about Cisco’s future in the storage market during the company’s 3Q15 earnings call, Robbins stated alliances have served Cisco well, but that he is considering all options.
TBR believes acquisition may be a strong route to quickly fill these gaps, given Cisco’s track record for successful M&A activity — especially as competition heats up from pure plays and Tier 1 multiplatform vendors.