Cisco Bear's Rebuttal
by Paul Larson ([email protected])

It certainly appears that Chris and I agree on something here -- Cisco is a great company. I also got a giggle how we both started our arguments pondering the handicaps of this particular Duel. However, we definitively part ways when it comes to looking down the road and deciding whether or not the future cash flows justify the current price.

Chris cited the fact that Internet traffic doubles every 100 days. Surely an amazing factoid if true, but why then is Cisco's expected long-term growth rate a factor of ten lower than this figure and in the 30% range? 30% annual top-line growth is still nothing to sneeze at, but Cisco's go-go days of 50-60% growth are behind it. At some point size becomes a major inhibitor of growth, and Cisco has come close to reaching that point.

Another brake to this hyper-growth rate is the particular markets Cisco has its eyes on for its future. Telecommunications hardware represents a completely different level of expected reliability than what happens on the Internet. When was the last time you picked up the phone and it didn't work? What about the Internet? How many times in the past week have you sat there twiddling your thumbs while the data you requested was flying around in limbo? The telephone companies have been demanding nothing short of perfection from the telecom-hardware providers (Lucent, Nortel Networks, Tellabs, etc.). This has battle-hardened the group to be an extremely proficient bunch, and this future competition will be much stiffer than Cisco's past competition.

Chris also points out that Cisco has a sales force numbering only 300. On this accord Cisco is massively out-gunned by the likes of its newest competitors in the telecom arena. Selling Internet hardware over the Internet makes sense. If anyone is going to be net-savvy, it is those buying routers and hubs. But is selling over the 'Net going to be enough of an attraction to unseat the established relationships Lucent has with its current customers who may not be hard-core computer users? A difficult question indeed.

Let's get back to the topic of valuation. Remember that all the good stuff -- stellar margins, 85% of the router market, inexpensive technical support, etc. -- are already built into the profits. Those 94 pennies in trailing earnings per share represent close to the company's top speed. A growing market for its products helps give the company a bit of a tail wind, but gaining any more market share or increasing margins is highly unlikely.

I noticed that my associate says little about the future valuation in his initial argument, and for good reason. An argument about the company's past success is as slanted against me as a debate about the valuation is slanted against Chris. In other words, it's an argument he can't win. If you're going to take home two numbers from the my initial argument just remember that Cisco's trailing P/E ratio is well over 80 while the expected long-term growth rate going forward is only 30%. Great stock to own yesterday? Absolutely. Great stock to own for tomorrow? Different story.

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