Cisco Bull's Pen
by Chris Rugaber ([email protected])

Ah, to be the bull for Cisco <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %> -- what could be easier? Whether you're talking about Cisco's tremendous earnings growth, share price performance, or balance sheet strength, the company presents an embarrassment of riches to those who would sing its praises.

Cisco is the networking gorilla. It is to networks what Microsoft is to software, what Intel is to microprocessors, what Dell is to personal computers: a high-margin, well-run company in a fast-growing industry.

To get a handle on Cisco's business, let's look at a small company's computer network needs. A relatively small office -- say, anywhere from 20 to 100 employees -- will presumably need a corresponding number of PCs, plus server computers that will house applications and large data files, plus printers. This is your basic Local Area Network, or LAN, and it usually requires switches, hubs, and other technologies to control data flow and basically direct traffic. Cisco has 35% of the overall market in switches and hubs.

Of course, everyone in the company will want to have Internet access for web browsing and e-mail. In addition, remote employees should probably have the same access to the office network as on-site employees. And all this raises security issues, of course. Cisco can provide routers for the Internet access (it's got 85% of that market), firewall and other security hardware and software, and dial-up access for your remote staff. There are a lot of small companies like this out there, and we've barely scratched the surface of Cisco's products and services. Aside from small and medium businesses, Cisco sells to "enterprise" customers -- large corporations, government, and educational institutions -- and telecom and Internet "service providers."

By organizing its business by customer size and type, rather than by product line, Cisco emphasizes the comprehensive nature of its services. You don't just buy routers from Cisco, you buy "end-to-end" network solutions. The company has set itself up as the one-stop network and Internet shop.

As networking and Internet capabilities become ubiquitous in businesses worldwide, Cisco will continue to profit handsomely. The company has increased revenues at a phenomenal five-year growth rate of 67%, and earnings per share (EPS) at a 41% clip. Its projected future growth rates are in the 30% range. Its stock price performance is, oh, kind of good. As pointed out in the Rule Maker Portfolio's buy report, since its IPO in 1990, Cisco's share price has grown at an annual rate of over 90%. It is the fastest company ever to reach a market cap of $100 billion, only 8� years after its IPO. It took Microsoft 11 years to do the same.

In short, Cisco is one of the leading beneficiaries of the explosive growth of the Internet, where traffic doubles every 100 days. But it's hardly just some company that was lucky enough to produce a few things important to the Internet. Instead, it is a tremendously efficient operation that makes extensive use of the Internet for sales and technical help, saving millions in the process. It has outsourced much of its manufacturing, and uses its network technology to efficiently manage its supply chain.

Cisco's products are complicated to set up and administer, but instead of having its engineers tied-up in tech support, the company built a highly detailed tech support website. As a result, approximately 70 percent of its product support is done over the web, without any loss of customer satisfaction. In fact, quite the opposite: Cisco wins awards for its customer service. CEO John Chambers estimates that the company's web tech support has saved them from hiring 1,000 additional engineers, and while its sales have quadrupled since 1995, its engineering support staff has only doubled.

Of course, tech support over the web is no big deal to most of Cisco's customers, since they probably purchased the products online. Cisco outpaces Amazon.com and even Dell in its web-based sales, and partly as a result, has only 300 sales agents. The company estimates that without its website, it would need 900.

Cisco also effectively uses internal networking. By outsourcing most of its manufacturing -- the company claims that its contractors employ five people in manufacturing for every one of its own -- it keeps overhead low, but without sacrificing efficiency. Its suppliers and partners have access to its intranet, through which they can monitor orders and ship the necessary hardware, sometimes directly to customers, without any specific input from Cisco itself.

As a result of this truly cutting-edge use of networking, Cisco estimates it saves $360 million a year in operating costs. This accounts for part of its outstanding margins -- 1998's operating margin was 32% -- and helps it spend over a billion dollars in research and development, which is impressive for a company with $8.5 billion in revenue.

But that's Cisco's past. Where are its future earnings going to come from? You can hear the bears right now: It better have a lot of those future earnings to justify a P/E of 80!

Rest assured, it's very likely to have the earnings. Let's remember that little Internet statistic: traffic doubles every 100 days. Not many companies have markets growing that fast. Secondly, there's the voice-video-data future, when all three are delivered over the same infrastructure. It's going to happen, and it's tempting to speculate on what it will mean (video e-mail? Any episode of Seinfeld on demand?). It will almost certainly mean a lot of money for companies that make the equipment that the internet/cable/phone providers use. Analysts have speculated recently that companies like Lucent and Nortel Networks may be the ones to capture most of this market, but Cisco has some definite advantages in this area. I'll have to cover those in my rebuttal.

Next: The Bear Argument