ANALYSIS - After years of buying, Cisco may need to sell

NEW YORK Mon Feb 28, 2011 10:59pm IST

John Chambers, chief executive of Cisco Systems, speaks during a news conference at at the 2010 International Consumer Electronics Show (CES) in Las Vegas, Nevada January 6, 2010. REUTERS/Steve Marcus/Files

John Chambers, chief executive of Cisco Systems, speaks during a news conference at at the 2010 International Consumer Electronics Show (CES) in Las Vegas, Nevada January 6, 2010.

Credit: Reuters/Steve Marcus/Files

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NEW YORK (Reuters) - For years, the question at Cisco Systems Inc was what to buy next, expanding from routers and switches into consumer electronics in an effort to keep its revenue rising by double digits.

Now, the question may be what to cut or sell off.

Since Cisco reported a weak outlook and lower-than-expected margins this month, investors and analysts wonder if it would be better off without some of its less successful businesses, including consumer router unit Linksys.

"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."

Analysts also mentioned cable set-top box unit Scientific Atlanta, as well as products like Cius -- a tablet computer for business users -- as things it could drop.

Cisco is trimming back marketing expenses for consumer products, including its new home videoconferencing system Umi, and is not preparing a sale of assets, according to company sources who declined to be named. But some investors and analysts said bolder steps may be needed.

A sale of Linksys and Scientific Atlanta would have been unthinkable until recently. A key part of Chambers' strategy has been to sell consumer products that help drive Internet traffic, and thus, boost demand for its routers and switches.

But in the most recent quarter, orders for consumer products fell 15 percent last quarter from a year earlier.

"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. His fund owns Cisco shares.

"Consumer technology is changing rapidly and there are big players like Apple and Google entering that space."

BACK TO BREAD AND BUTTER

Traditional rivals like Juniper Networks Inc are challenging Cisco's market position in routing and switching. But they aren't the only ones vying for a greater piece of corporate spending.

Onetime sales partner Hewlett-Packard is now a fierce rival, having bought network equipment maker 3Com after Cisco's foray into HP's server territory.

China's Huawei Technologies Co and ZTE Corp are also gaining strength, while analysts say Alcatel-Lucent is recovering from post-merger confusion and winning more accounts.

"Cisco needs to figure out where they want to continue to play, and ... whether they need to exit some product lines," said Mizuho Securities analyst Joanna Makris.

Chambers told investors on a Feb. 9 conference call he was forming a working group to boost margins, and has since made some changes.

Last week, the company killed an experiment with Cisco Mail, an e-mail service that tried to compete with Google Inc and Microsoft Corp but never took off. Some analysts said the move was an admission that its $215 million acquisition of PostPath was a failure.

Cisco also created the role of Chief Operating Officer to improve the way its different units worked together.

WAS FLIP A FLOP?

Some say that Cisco may even be regretting its $590 million acquisition of Flip videocamera maker Pure Digital in 2009, and could sell or cut investment in the unit.

The Flip camera has become the most popular pocket camcorder in the United States, with a simple design and easy-to-use software for uploading photos. But it competes with devices made by Sony Corp as well as video-capable smartphones.

Critics also say the Flip camera is starting to look old. Unlike corporate routers and switches, consumer products require frequent improvements to stay fashionable --something companies like Apple and Sony have more experience with.

A day after its quarterly report, Cisco said the head of its consumer business group and former Pure Digital CEO Jonathan Kaplan was leaving.

Chambers said he doesn't regret the company's expansion. Since he took over as CEO in 1995, Cisco's annual revenue has grown from around $1 billion to $40 billion last year.

"The only criticism I would have is, we should have prioritized... And what we have to do is take resources and realign them," he said on a conference call with Bank of America Merrill Lynch analysts last week.

With over $40 billion in cash, Cisco is still expected to look for deals. But investors are hoping for more prudence -- fewer deals like PostPath and Pure Digital and more like wireless technology firm Starent and online conference WebEx.

Capital Advisors' Smith saw opportunities for Cisco to invest in technologies like smart grid, or utilities systems that are connected to the Internet, and increasingly popular cloud computing technologies that allow users to cut hardware and energy costs.

But he added investors will take a close look at any purchases ahead.

"You'll probably see something, probably in the next 6 to 12 months. But with their mixed record, investors are going to scrutinize acquisitions going forward."

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