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Cisco's SDN defense takes a hit

JP Morgan downgrades stock, says price comparisons with merchant switching off base

JP Morgan has downgraded Cisco's stock based on challenges in emerging markets, and on the potential impact of software-defined networking (SDNs). This is at least the second Wall Street investment firm that predicts a rocky road ahead for Cisco in the age of SDNs: last fall, Credit Suisse issued a detailed report on the negative effect SDNs could have on Cisco.

JP Morgan tore apart Cisco's "self-defense" against SDNs, which it shared with financial analysts last month. As noted by this Barron's blog, Morgan takes issue with Cisco assertions that its hardware and software actually offer lower capital and operating expenses than commodity switches based on merchant silicon running network virtualization software.

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Cisco claims its Application Centric Infrastructure product line can provide a 75% reduction in total cost of ownership over merchant switches running network virtualization software, and that branded switches with integrated hardware and software can lower switch capital expenses by 27% over disaggregated white box hardware and software.

Morgan disagrees, referencing a slide Cisco displayed at the analyst conference:

There is a lot wrong with this analysis in our opinion. First, we believe the $4,000 price shown above is Cisco's absolute rock bottom provided only to hyperscale web customers. Second, the price does not appear to include Smartnet or L3 license fees. We agree that Smartnet is likely to be tossed in with larger deals but don't expect that to be the case with L3 licenses. Finally, we believe that the $1,000/yr for the Whitebox OS is inaccurate in this scenario. We believe that the real license fee in that case could drop to something closer to $200/switch/year.

Indeed, Morgan downgraded Cisco's stock from Neutral to Underweight based on its view that, in addition to a softening emerging markets theatre, SDN and bare metal switching will erode Cisco earnings:

Cisco solutions priced as they have been historically are significantly more expensive than bare metal even when we eliminate Cisco Smartnet... Second, a large chunk of Cisco's price premium is related to Smartnet which could easily be reduced... However, our analysis shows that, even without this fee, the price difference is material.

ACI has its work cut out for it.

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