For more than a decade, Cisco has used its substantial financial resources to keep disruption at bay. While its bread-and-butter business has always been, and remains, networking equipment, for much of the last 15 years, it has tried to morph into a software and services company by buying up smaller tech firms regularly.
As I wrote last year, the company has bought 30 startups over the past several years, and it has a long history of building its business on top of acquired entities. If you go back to its origins in the ’90s, Cisco has been involved in more than 200 acquisitions.
The approach has helped the company report decent revenue growth over the years, but the disruption dogs might have finally caught up. Its latest quarterly results, while not downright ugly, did appear to show a company treading water.
The bad news goes beyond the numbers
For starters, Cisco said revenue was flat from a year earlier at $12.8 billion, while analysts were expecting $13.3 billion — a substantial gap. Unfortunately, the bad news didn’t end there.
“Even when the supply chain issues are solved, Cisco must find a way to innovate and monetize in networking — something it has been struggling with over the last four to six years.” Holger Mueller, analyst at Constellation Research
The company also expects current-quarter revenue to fall 1% to 5.5%. That’s quite a broad range, but any way you slice it, we’re looking at a decrease while analysts were anticipating growth of around 6%.
The next year looks blah as well, with growth pegged at a mere 2% to 3%. To be clear, that’s better than declining revenue, but it looks like the company’s acquisition strategy might not be doing enough to compensate for the lack of revenue from its networking hardware business.
Why does it matter if the revenue growth is slow? Well, slowing revenue growth can turn negative, and it implies that the company’s profitability in the future will be constrained by its current size.
Given that its rivals’ revenues are rising, and therefore they have more potential upside, declining revenues could make it harder for Cisco to hire and buy — who wants to work for a company when your equity compensation has limited potential for growth? — and it’s harder to buy other companies with a stock that is in the doldrums.
We’ve seen public tech companies that fell, or flirted with, single-digit growth wind up under external pressure to sell, sack leadership or break into smaller pieces. Given that Cisco likely doesn’t want any of those things to happen, the rate of revenue growth is critical.
Revenue type matters as well
Lately, Wall Street hasn’t been kind even to companies that have posted substantial increases in revenue. So perhaps it wasn’t surprising when Cisco’s stock dropped 13% the day after it reported.
CEO Chuck Robbins blamed supply chain issues, especially in China, and Russia’s invasion of Ukraine for his company’s troubles in the company’s earnings call with analysts on Wednesday.
“We believe that our revenue performance in the upcoming quarters is less dependent on demand and more dependent on the supply availability in this increasingly complex environment,” he said.
“While certain aspects of the current situation are largely out of our control, our teams have been working on several mitigation actions to help alleviate many of the component issues that we’ve been facing,” he added.
That may sound like some serious excuse making, but Robbins also pointed to some other external conditions having an impact on the company, like the loss of business in Russia: “Number one, without the two percentage points of orders that we de-booked relative to Russia and Belarus, we grew 10% against a year-ago growth of 10%.”
He added that Cisco customers are suggesting that they are not pulling back from purchase plans in a substantial way.
“Our customers are not signaling any real shift at this point. We’re not hearing that from them. Again, we had our global customer advisory board just a couple of weeks ago, where we had 100 of our biggest customers, and they were all talking about projects in the strategic nature of everything they’re trying to accomplish,” he said.
Subscription revenue may not be a lifeline
The bottom may be dropping out of the company’s hardware business due to supply chain problems, at least for now. But Cisco also has to deal with the same economic issues as everyone else, and they need the subscription side of businesses to hedge against that.
Companies around the world are working to grow their software incomes not only because investors like those revenues, but also because they tend to be recurring — and therefore more stable — and self-expanding to a degree. In short, they are the antithesis of hardware top line.
So Cisco’s move to add more software incomes is not only a good hedge against the ups and downs of the hardware market — it’s also a way to ensure that its revenues keep growing. It also doesn’t hurt that software incomes tend to be high margin.
But Patrick Moorhead, founder and principal analyst at Moor Insights & Strategies, said software revenue streams, no matter how many billions Cisco has invested, cannot make up for the loss of the hardware business.
“As a percentage of revenue, these software and services numbers can’t compensate for a large drop in equipment,” he said. For reference, Cisco’s networking equipment segment reported revenue of $5.9 billion in its most recent quarter, making up 63% of product revenue, which came in at $9.4 billion.
He sees the problem through the same lens as Robbins: The supply chain malaise is having a profound impact on the company.
“I believe this is primarily about Shanghai ports not operating [combined with] not selling into Russia. While I don’t think every infrastructure company will have this challenge, those locked into the Shanghai supply chain or with large Russian businesses will,” he said.
Cisco is dealing with both issues to some degree, although the 1% loss of revenue from Russia doesn’t really account for all of its problems.
“Many of the company’s services are subscriptions for hardware and without [actual] hardware — it’s eating into that revenue stream. The equipment still needs to be shipped somewhere,” Moorhead said.
But Holger Mueller, an analyst at Constellation Research, said that the supply chain problems are just part of what’s going on, and Cisco has deeper innovation issues. “Cisco was struggling to catch growth before the pandemic, and the pandemic spending boom has glossed things over,” he said.
“Even when the supply chain issues are solved, Cisco must find a way to innovate and monetize in networking — something it has been struggling with over the last four to six years. Basically, Cisco has no response for core networking spend disappearing from on-premises, due to the move to the cloud. And like fellow ‘old guard’ vendors such as Dell, HPE, etc., it has not been able to sell its gear to the cloud providers to make up for it.”
So is Cisco in a short-term hole due to circumstances beyond its control, or is disruption finally catching up? If the economy drops into recession this year or the next, the company’s problems could grow worse, and it doesn’t seem like all those dollars spent on software companies will do much to soften the blow.