Cisco in spotlight as Ethernet switching gains

"Overall IT spending is growing in spurts, but Cisco in our view is out-executing its peers in LAN (local area network) switching and is enjoying strong growth in its router and advanced technology segments," Mark Sue, an analyst at RBC Capital Markets, wrote in a research note published late last week.

Cisco is the last Ethernet switching vendor to report earnings this season. Competitors Enterasys, Extreme Networks, Foundry Networks and Radware have all recently reported results for the second calendar quarter of 2004. With the exception of Foundry, all of these companies have met expectations and have grown their businesses.

But equities analysts who cover Cisco say their checks into the company's sales channel suggest that it is likely stealing business from competitors in the Ethernet switching market. Many of these analysts have reiterated their bullish ratings and pushed earnings estimates to the high end of the company's sales guidance given during the previous conference call. Cisco will report earnings Aug. 10. The company officially closed its quarter July 31.

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"We believe that despite concerns seen in some areas of tech, Cisco's general demand trends have remained solid through July led by strength in the core U.S. enterprise division with European enterprise also solid," Tim Luke, an analyst with Lehman Brothers, wrote in a research note. "We continue to believe Cisco may be positioned to deliver results at the higher end of sales guidance of up 3 percent to 5 percent or possibly slightly above this range."

Analysts Luke and Sue expect Cisco to report revenue of roughly $5.8 billion for the quarter.

Among early forecasts, Synergy Research analyst Joshua Johnson said he expected the entire Ethernet switching market to be up 6 percent in the second quarter. But he believes that Cisco could push this figure up even further.

"My estimate was probably a little conservative," he said. "Cisco has done well the last few quarters, and I expect the momentum to continue, even though the second quarter is typically not a big one for enterprise spending."

In the first quarter of 2004, Cisco, which has almost 70 percent market share, grew Ethernet switch sales by 28 percent from the previous quarter. Cisco's gains helped bump up the entire market roughly 21 percent overall. The company's growth in this market has outpaced the market as a whole, and it has managed to steal market share from just about every competitor including Nortel Networks, 3Com, Foundry Networks and Extreme Networks, Johnson said.

There are two main factors driving sales of Ethernet switches, he explained. One has to do with the upgrade cycle of products. Many of the Ethernet switches that are deployed in networks were purchased in 1999 in preparation for Y2K. But now that gear is at least 5 years old, and IT managers realize those switches don't provide the features or bandwidth necessary to carry them through the next five years. Because the equipment has already depreciated, IT managers are able to increase their budgets and allocate more spending toward the purchase of new gear, Johnson said.

Another important driver in the Ethernet switching market is the convergence of voice and video onto Internet Protocol data networks. As corporate IT managers think about adding streaming video or voice over IP to their networks, they are looking for new Ethernet products that provide better quality of service, security and more bandwidth. As a result, customers are spending more on 1gbps (gigabit per second) Ethernet and 10gbps Ethernet interfaces.