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CIBC analyst: Cisco&#039&#039s glory days are over

Cisco (Nasdaq: CSCO) took an initial hit Wednesday after a CIBC World Markets analyst said that the networking giant's glory days may be over.

Shares were off 3.06 to 34.06, or 8 percent, in early trading, but rebounded by midday. The company has already suffered from a host of downgrades based on a slowdown in capital spending.

CIBC World Markets analyst Steve Kamman downgraded Cisco, along with several networking equipment companies including Juniper Networks (Nasdaq: JNPR), which was dropped to a "buy" rating from "strong buy," and Redback Networks (Nasdaq: RBAK), which was cut to "hold" from "buy." Lucent (NYSE: LU) was upgraded to "buy" from "hold."

Kamman's downgrade of Cisco to "hold" from "buy" wasn't a new idea, but his take that the company will become a bloated giant was interesting. Based on short and long-term concerns, Kamman said the company is fulfilling the prophecy of Clayton Christensen's book "The Innovator's Dilemma," where dominant companies falter because they cling too long to a business model based on sustaining technologies rather than disruptive ones.

The gist of Kamman's thesis is that Cisco won't be able to continue its rapid acquisition pace to keep a technological edge. Kamman joins an increasingly vocal minority of analysts doubting Cisco's growth potential. "All acquisition-driven strategies inevitably must end," said Kamman.

Not all analysts agree. In a research note last week, Lissa Bogaty, an analyst with CS First Boston, said Cisco's quarter is "in good shape." Coupled with a cut in interest rates that should boost capital spending, Cisco should be able to continue its traditional growth rates," she said.

While presenting at the Morgan Stanley Dean Witter Internet, Software & Networking Conference in Scottsdale, Arizona, CEO John Chambers didn't rule out that the company could be affected by a slowdown in capital spending, but didn't give specifics about financials. The company is seeing "a little bit more challenging" second quarter and didn't have "good visibility into the next two quarters."

Bogaty projected that Cisco shares should trade in the $50 range. "We believe that the stock can move up to the low $50's near term, as investors feel comfortable and project this multiple onto next year's earnings," she said. "We think it will move above this range as Cisco proves that it is less cyclically sensitive than some are worrying about."

Kamman said it's doubtful that Cisco can continue its current growth.

"We believe Cisco will not make consensus revenue estimates in fiscal year 2002 and expect will it no longer be able to rely on appreciating stock as a currency," Kamman stated in his report. He said 30 to 40 percent revenue growth is now mathematically unlikely, and expects a long-term revenue growth rate of 20 to 25 percent from now on.

Kamman said Cisco is likely to see a slowdown over the next six months. He also said the company's failure to develop an OC-192 interface card, and its loss of 30 percent share to Juniper (Nasdaq: JNPR) does not bode well.

He recommended that investors wait the transition out. He said Cisco will stay dominant in the enterprise market, but may falter in the service provider business.

The company is not "well positioned to meet an expected tsunami of changes in the telecom market," because its "end-to-end" strategy and "intelligent network" vision run counter to fundamental trends in the industry, said Kamman.

He described a coming telecom shakedown where carriers cut costs by building out lower-cost network designs, rather than increasing revenue by adding new features and services, as Cisco currently expects them to. Kamman also noted a trend towards specialized horizontal service providers which will to look to buy from equally focused equipment suppliers.

Brain drain will also continue as Cisco loses high-level execs, said Kamman. To keep employees, the company may re-price options.

The analyst painted a grim picture for the company; he expects it will "either increase cash compensation or option grants to try and stem the tide ... (creating) a strong negative feedback loop, with re-pricing/cash grants spurring further stock drops, leading to further departures."