Cisco's Dividend Announcement and a Little Corporate Finance Shows How Cisco is Changing

Rapid Growing Tech Companies Don't Pay a Dividend

(I'll finish up WAN Transformation next week.)

WARNING - this blog has boring corporate finance stuff and no mention of bandwidth, router models, or cool geek stuff like BGP routing. But, this is something all of us should understand, particularly if you have aspirations to be a senior architect or a manager someday (or already are). Networks are built for business and finance is the language of business.

I'm in the final semester of my MBA at NC State University. It's been a great experience and I have learned a lot. My concentration in the MBA School is corporate finance. I have no intention of leaving IT to be a CFO or investment banker, but having a good understanding of finance is particularly important in IT. In rough terms, IT is 50% technology and 50% finance (budgets and business cases). My corporate finance classes gave me some simple insight into Cisco's announcement of a corporate dividend and how the company is changing. Cisco has forever marketed itself as a hip, growth oriented, fun networking company. That image still remains, but Cisco's growth and acquisitions over the years have brought it to a size that delivering, financially, like a smaller tech company, is very hard. Every company (public or not) needs to provide a return to investors. If you buy Cisco's stock you expect a return (via either increased stock price or dividends or a combination of both). Just as you expect a bank to pay you interest on your savings account, you expect a rate of return on stock. For companies, this "rate of return" is generally called "Return on Equity" or "Cost of Equity". It's what stock holders expect to get by owning the stock. Using some financial formulas Cisco, internally, determines the rate of return is should shoot for when deciding on new product lines, doing M&A, or starting projects.

If you're interested, these financial formulas are called the "Capital Asset Pricing Model" and the "Weighted Average Cost of Capital". But, proceed with caution. :-)

Let's say Cisco's targeted rate of return is 15%. Thus, anything new Cisco decides to do - new product lines, doing M&A, or starting projects - needs to expect to return 15%. When you're smaller and growing and doing M&A to get into "market adjacencies", 15% isn't so hard to accomplish. In fact, several years ago, Cisco was probably pulling in 50% return on individual projects. When you can significantly exceed your 15% goal you keep all the cash you've earned as profits and re-invest that cash into new projects (i.e. you don't give back your cash by paying a dividend). This is how growth is financed. But, now things are changing. The economy is worse and Cisco is bigger. Finding enough new product lines, projects, and market adjacency M&A companies is harder. Yes, Cisco could still buy 30 small companies, but integrating them into a company with 70,000 employees is much harder. Thus, achieving that 15% gets harder. In fact, Cisco's latest return on equity was 18.73%. Still above 15% and still very good, but getting closer. Thus, because it's gotten harder to find good projects, Cisco's cash is going unused and sitting in a bank account. This happens to a lot of companies as they grow - just ask Microsoft. So, Cisco now can't find a bunch of really good business options and it's sitting on a ton of cash. Stockholders then start to say, "look Cisco, if you can't find really good projects to use that cash on, just give it back to me and I'll use the cash to buy something else". Thus, a dividend is announced. What does this mean? It means Cisco has grown up. They're a big IT company, not some small, rapid growing tech company from Silicon Valley. They're closer to IBM and HP than Juniper and Facebook. But, I think that's what Cisco wants. Cisco is still very innovative with Nexus, UCS, Telepresence, and Cius. But Cisco's future value proposition is "trust us with your entire IT portfolio like you would trust HP, we are big, strong, and stable too". Announcing a dividend is further indication that change is well underway.

More >From the Field blog entries:

WAN Transformation is a Huge Project

WAN Transformation is a Go!

Cisco Unified Computing System is 75% Networking - Who Knew?

Congress Needs to Step In for Net Neutrality...Really? Seriously?

It's Time to Start Loving Tunnels

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