Industry analysts say Cisco could be hurt by less spending on network gear
Reports from two stock analysts this week point to a possible slowdown in Cisco’s core enterprise business, and pressure for Cisco to meet service provider sales goals — trends which could reflect harder times overall in the IT and networking markets.
In separate reports, Samuel Wilson of JMP Securities cited a slowdown in enterprise spending that could affect Cisco’s enterprise switching and routing sales in its third fiscal quarter; meanwhile, analyst Tim Daubenspeck of Pacific Crest issued a report saying Cisco’s service provider group is under pressure to generate more revenue as the quarter nears its end on April 28.
While other industry watchers say the enterprise network and IT equipment market is healthy, JMP’s Wilson points to warning signs at Cisco as reflection of an overall slowdown in the spending on basic infrastructure or “capacity” IT gear, such as routers, switches and servers.
In its second fiscal quarter, which ended Jan. 27, Cisco’s U.S enterprise order growth dipped into the “mid-single digits” from 20% growth in the previous quarter. In January, Cisco attributed this partly to multi-national enterprise customers expanding overseas, and CEO John Chambers said he did not expect the trend to continue.
“CIOs are sitting on discretionary spending right now,” Wilson says of the enterprise spending landscape. “This is more on the capacity-driven parts of [IT].”
Wilson says enterprises buy network and IT gear for two reasons: to add new services and features, or to add capacity. “Capacity is driven by things like hiring, businesses expanding,” he says. With network technologies “like WAN optimization and layer 4-7 — the new stuff — spending continues to be solid there. Then there’s the enterprise routers, Ethernet switches, servers. That’s what’s feeling it” in terms of slowdown.
Wilson points to recent U.S Department of Commerce statistics as a warning sign for Cisco and other “capacity” technology vendors. Shipments and new orders of computers and related products in March were both down 5.2% and 3.7% respectively, compared with March 2006; with communications equipment shipments down almost 3% and new orders down almost 5%.
Wilson says any trouble Cisco finds itself in could stem from the company’s emphasis over the past several quarters of its advanced technologies — VoIP, WLAN, security and video, and application, storage and home networking — over its core technologies of routing and switching.
“[Most of] Cisco’s business is that plain Jane stuff,” Wilson says.
For its part, Cisco last month began giving deep discounts to its channel partners on enterprise routing and switching products in an effort to boost sales of infrastructure gear and give better profit margins to its resellers. Discounts as much as 48% off list price are part of the Opportunity Incentive Program for some resellers, on deals worth a minimum of $50,000. Cisco says its resellers in the past have emphasized advanced technologies (such as VoIP, WLAN and security) over infrastructure products because the technology had higher resale margins.
“We had started sending messages to partners, our sales force, everybody, that it was all about the ATs [Advanced Technologies],” over the last few years, says Marie Hattar, senior director of network systems marketing at Cisco. “We were realizing, wait a minute … this other stuff is still very, very important. So we’re just doing some adjustments so our partners realize that [routing and switching] is just as important.”
While looking to spur sales with deep switching and routing discounts for partners, Cisco is also anticipating an uptick in demand for network infrastructure.
“We do anticipate that we’re going into a market upgrade cycle on the routing side,” Hattar adds. “This isn’t’ coming from Cisco. This is something a lot of market research firms are anticipating. Part of it is that the equipment there is aging [in enterprises]. Platforms, such as the 7500, have been in place for over 10 years.”
Specific research that backs this up comes from Goldman Sachs, which says 72% of the 100 IT executives it surveyed in October 2006 said they would increase network spending over the next 12 months; of those expecting to spend more, 55% said they would increase their spending on Cisco products.
More broadly, Infonetics Research says spending on network technology by enterprises and service providers will continue to grow 20% over the next several years, reaching $148 billion worldwide by 2010.
In service providers, the outlook for Cisco in the report from Daubenspeck of Pacific Crest Securities’ was less negative, although the urgency to scrape for revenue at the end of the quarter seemed curious, the analyst says.
“There’s been concern about U.S. enterprise and a lot of kind of comments around U.S. enterprise and weakness in U.S. enterprise. But we were a little surprised to see that service provider was pushing a little bit harder here towards the end of the quarter,” Daubenspeck says.
Last week, Cisco announced major deals to install its flagship CRS-1 terabit routers into the networks of AT&T, where it is replacing Avici routers, and Swedish carrier TeliaSonera. Although the company did lose a large hosted VoIP contract to Nortel in Mexico in the same week.
“We don’t think there’s anything fundamentally wrong,” Daubenspeck says of Cisco’s enterprise business. “We don’t think they’re in danger of missing the quarter, nor do we think they’re going to materially change guidance.”
