Elevating Growth Through Tactical Acquisitions And Innovation In AI And Cybersecurity

Key Takeaways

• Cisco's acquisition of Splunk and introduction of Cisco Hypershield aim to enhance its software solutions and security services, potentially boosting revenue growth.
  
• Shifting towards a subscription-based business model and investing in AI infrastructure are strategic moves expected to stabilize earnings and tap into emerging technology sectors.
  
• Financing the Splunk acquisition and higher debt interest may pressure earnings, while operating costs, customer inventory adjustments, and macroeconomic uncertainties challenge revenue and profit growth.

Catalysts

Designs, manufactures, and sells Internet Protocol based networking and other products related to the communications and information technology industry in the Americas, Europe, the Middle East, Africa, the Asia Pacific, Japan, and China.

• Cisco's recent acquisition of Splunk is expected to bolster long-term growth through an expanded portfolio of software-based solutions, potentially increasing annual recurring revenue and enhancing its position as a top software company, positively impacting revenue growth.
  
• The introduction of Cisco Hypershield, a groundbreaking AI-powered approach to highly distributed security, combines security and networking uniquely, offering potential enhancements in product offerings and strengthening competitive positioning, which can lead to revenue growth in security services.
  
• The shift towards a business model with more than half of the total revenue coming from subscriptions, even before adding Splunk, indicates a stable and predictable revenue stream, likely improving net margins and earnings stability.
  
• Investments in AI infrastructure, including partnerships and product orders expected in fiscal year 2025, position Cisco to capitalize on the AI application proliferation in enterprise, potentially driving significant revenue growth in this emerging sector.
  
• The rapid integration of Splunk into Cisco's go-to-market strategies and product offerings, particularly in security and observability markets, alongside leveraging Cisco's extensive partner and customer ecosystem, can create revenue synergies, contributing to overall growth and financial performance.

Assumptions

• Analysts are assuming Cisco Systems's revenue will grow by 4.2% annually over the next 3 years.
• Analysts are assuming Cisco Systems's profit margins will remain the same at 19.2% over the next 3 years.
• Analysts expect earnings to reach $11.7 billion (and earnings per share of $3.15) by about October 2027, up from $10.3 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $13.5 billion in earnings, and the most bearish expecting $10.4 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.6x on those 2027 earnings, up from 21.5x today. This future PE is lower than the current PE for the US Communications industry at 24.6x.
• Analysts expect the number of shares outstanding to decline by 2.37% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.58%, as per the Simply Wall St company report.

Risks

• The interest costs associated with financing the Splunk acquisition and additional interest payments on debt could put pressure on Cisco's earnings per share (EPS). This financial strain might negatively impact net income.
  
• Increased operating expenses (OpEx) expected for fiscal year '25 to drive revenue synergies from the Splunk acquisition could dilute Cisco's profit margins if the anticipated revenue growth does not materialize as rapidly or robustly as planned.
  
• The ongoing inventory digestion by customers, leading to a temporary slowdown in product orders, could result in short-term revenue headwinds. If order growth does not resume as expected post-digestion, Cisco's revenue growth may falter.
  
• Despite expectations of returning to growth, underlying caution is noted regarding macroeconomic uncertainties and potential election impacts, which could unpredictably affect customer spending and Cisco's revenue.
  
• Integration and competitive challenges with Splunk, coupled with the rapid consolidation and competitive dynamics in the cybersecurity and SIEM markets, may affect Cisco's ability to realize the expected revenue synergies from the Splunk acquisition. This could ultimately impact overall revenue growth and profitability in the competitive software-based solutions market.

Valuation

• The analysts have a consensus price target of $56.25 for Cisco Systems based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $78.0, and the most bearish reporting a price target of just $49.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $60.9 billion, earnings will come to $11.7 billion, and it would be trading on a PE ratio of 21.6x, assuming you use a discount rate of 6.6%.
• Given the current share price of $55.68, the analyst's price target of $56.25 is 1.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.