Should Cisco Sell?

Story suggests some operations, product lines be shed in light of recent results

Should Cisco sell off some operations after setting the standard for years in acquiring and successfully assimilating companies into its enterprise? That's the question Reuters asked in a recent article reviewing the company's financial challenges of late.

The company has acquired 144 other companies since 1993, helping it grow from $700 million in revenue then to $40 billion now. Cisco boasts that its success rate with acquisitions is 70% while industrywide the failure rate is 90%.

But recent events have led many observers to question whether Cisco's bitten off more than it can chew. It struggled in newer markets, like set-top boxes and consumer, in its most recent quarter. Cisco purchased its way into set-top boxes with the $7 billion acquisition of Scientific-Atlanta in 2005, and paid a combined $1.1 billion for Linksys, a maker of home routers, and Pure Digital, a maker of pocket videocams.

But CEO John Chambers and CTO Padmasree Warrior acknowledged last week at the Cisco Partner Summit that the company's end-to-end architectural sales model is not working on the consumer or SMB spaces. Cisco can't "upsell" consumers on other products with which to fill out their home networking and digital entertainment systems; and SMBs just want their problems solved, Warrior said, not to be sold on a broad, sweeping blueprint for changing business processes.

So might it be time for Cisco to not only reconsider how it sells into these markets - but to reconsider its presence in them altogether? Analysts quoted in the Reuters story say it might be time to shed some businesses:

"What investors would like is to see them more focused on their core market, like routers, switches and data centers, and de-emphasize or even exit some of these consumer businesses," said Morningstar analyst Grady Burkett. "We want to see Cisco accept the fact that it's not going to grow in the mid-teens, or the 12 to 17 percent that they've been targeting, and instead focus on returning capital to shareholders and defending its core markets."

The cable set-top boxes from Scientific-Atlanta and the new Cius tablet are also products Cisco should consider divesting, analysts in the Reuters story said. Cisco sources told them the company is cutting marketing expenses on consumer products but not product lines - like it did its hosted e-mail offering.

Cisco's entry into the consumer market was intended to boost Internet traffic, preferably with video, to drive follow-on demand for its routers and switches in order to increase the capacity of the Internet. But Cisco overshot the consumer market in its fiscal second quarter, pushing "high value" architectures instead of feeding consumer appetites for "low value" commodity devices.

Consumer revenue was down 15% in Q2. Sales of the Flip videocam were half of what Cisco hoped. Orders for set-top boxes decreased 15% in Q2 from last year, and cable set-top box revenue plummeted 29%.

Consumer chief Jonathan Kaplan, who came over with the Pure Digital acquisition, left the company soon after Q2 results were announced.

At the same time, Cisco core businesses of routing and switching are under pressure. Switching revenue was down 7% and profit margins were squeezed due to what Chambers and other Cisco executives say is the most significant product transition in that business for the company. And in a telling admission, Chamber's acknowledged that the hit in switching in Q2 took he and his company by surprise.

Routing revenue was up 4% from last year but down 7% from Q1. Meanwhile, sales of new products - data center, virtualization, mobility, video, collaboration - and services surpassed that of routers and switches combined for the first time in company history.

The result is a transition in Cisco's entire business, from bedrock routers and switches as its main revenue drivers, to sales of new products and associated services borne of the company's 30-odd market adjacencies.

But analysts say it's time for Cisco to stick to its knitting:

"In the longer term I wouldn't be upset to see those businesses go," said Channing Smith, managing director for Capital Advisors Growth Fund, referring to both Linksys and Scientific Atlanta.

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