Cisco Systems

Company background
Cisco Systems, Inc. is a worldwide leader in the networking communication equipment
industry. They design; manufacture, and sell networking and other related products to the
communications and information technology industry as well as providing services
associated with these products. Their clients include corporations, public institutions,
telecommunications companies, commercial businesses and private residences.

In !" #$$%, appro&imately '() of Cisco*s net sales were generated from product
revenue with only %) coming from service revenue.
Industry setting
The primary drivers of the industry are corporate information technology spending and
telecommunication capital e&penditures. The popularity of the Internet increases the
bandwidth demand, and internet+related companies are constantly upgrading and
replacing relatively obsolete network equipment to meet this increased demand.
Companies in the networking communication equipment industry definitely benefit from
this upward demand and will continue to e&perience steady growth despite a high
penetration in the some segments by competitors.
#

,s a leader in the -oI. market, Cisco definitely benefits from this growth as the /0S
cable companies continue to push into the -oI. market by offering an attractive /triple
play1 bundle of voice, video, and data.1
2

Company Analysis
Business Strategy
Cisco believes that /the key to long+term success in the high+tech industry is ongoing
strategic investment and innovation1
(
To support their innovative vision, the company
spends heavily on 3esearch and 4evelopment. To support its growth strategy, Cisco
aggressively acquires companies operating in different niche markets. !or e&ample, Cisco
acquired 5inksys, a home+networking hardware company, 6iSS, a network+enabled 4-4
player company, and Scientific+,tlanta, which is a set+top bo& manufacturer that controls
7$) of its market.
7
These acquisitions mark a ma8or strategy shift for Cisco, which has
increasingly e&panded its business into private residences.
In line with its global growth strategy, Cisco recently announced that it would invest 9.
billion over ne&t three years in India and e&pected to increase headcounts
%
as well to take
advantage of India*s low+cost raw materials and labor.

Cisco Systems, Inc . Corporate :verview, 3etrieved :ct ', #$$%

http;<<newsroom.cisco.com<dlls<company=overview.html
#
S>. Industry Survey; Communication ?quipment. 3etrieved :ct. $, #$$%.
2
@ergent :nline. IT industry. 3etrieved :ct.$, #$$%.
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Cisco Systems. ,nnual 3eport. 3etrieved :ct.$, #$$%.
7
Ibid.
%
CAA @oney. Cisco looks to India for growth, workers. 3etrieved 4ec. %, #$$% from
http;<<money.cnn.com<#$$%<#<$%<news<international<bc.cisco.india.reut<inde&.htmBsourceCyahoo=quote
Products and Market
Cisco*s core product lines include routing, switching and advanced technologies such as
I. communications, network security and wireless 5,A, etc. ,s shown in ?&hibit ,
switching is Cisco*s ma8or product line and represents appro&imately (7.2) of their total
product sales. ,ll product lines e&perienced growth between !" #$$7 and !" #$$%,
resulting in a (.D) increase in total net product sales. In particular,, ,dvanced
Technologies e&perienced a significant increase of 2(), which mainly resulted from the
increase in net product revenue from the acquisition of Scientific+,tlanta.
D
Cisco
anticipates the synergies of the acquisition will continue to add value to the company in
the video market.
'
Cisco also introduced a new product, Tele.resence, into its advanced
technologies line in :ctober, #$$%. This product enables users to have lifelike
teleconferences over the Internet protocol EI.F network. Cisco e&pects this product to
generate 9 billon in revenue by #$2. It is estimated that if overall video demand
increases infrastructure sales by merely ), Cisco would gain 92% million in gross
profits.
G

Exhibit 2
Net Sales by Markets
55%
21%
9%
10%
5%
United states and
Canada
European Markets
Emerging Markets
Asia Pacific
Japan
ESource; Company reportF
D
Cisco Systems, #$$% ,nnual 3eport. .g #%. 3etrieved on :ct. #%, #$$%.
'
H$D Company conference call
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Stuarat, 4onald, Iillis, 4avid. Cisco Jeats up Competition in the -ideo Telepresence @arket.
E:ct.#$$%F. 3etrieved :ct. 2$, #$$% from
http;<<www.gartner.com<4isplay4ocumentBdoc=cdC(((G2>refCg=homelink
Exhibit 1
EAumbers are in millionsF !" #$$% !"#$$7 ) change
Aet product sales
3outers 9%,$$7 97,(G' G.#$)
Switches 9$,'22 9G,G7$ '.G$)
,dvanced Technologies 9%,##' 9(,%2( 2(.($)
:ther 9'7 9DD $.($)
Total 9#2,GD 9#$,'72 (.D$)
,s shown in ?&hibit #, Cisco*s business is comprised of five geographical regions. 0S
and Canadian markets accounted for 77) of the overall net sales markets in !" #$$%.
Cisco e&perienced growth in every region, especially in the emerging markets. ,lthough
the ?merging markets represents only G) of net sales, this market grew by 2') between
!" #$$7 and !" #$$%.
Production and distribution
Cisco had to write off 9#.2 billion in inventory and lay off ',7$$ workers when the high+
tech sector e&perienced a sharp decline in #$$. Since then, the company overhauled its
supply chain and /simplified its entire operating structure, from design through
component sourcing to manufacturing and logistics1
$
!or e&ample; more than /77
percent of CiscoKs manufacturing was done internally in #$$, with the remainder being
outsourced. Currently, contractors make more than G$ percent of the companyKs
products.1 To take advantage of the low+cost of raw materials and labor, Cisco has been
shifting some of their operations to China and India.
In the third quarter of !" #$$%, Cisco began the initial implementation of the lean
manufacturing model. /5ean manufacturing is an industry+standard model that seeks to
drive efficiency and fle&ibility in manufacturing processes as well as the broader supply
chain.1

This supply chain strategy enhances Cisco*s ability to cut manufacturing costs
and better mange their inventory levels.
Cisco sells its products to appro&imately 7 countries and has built large product
channels both domestically and internationally. Cisco offers its products and services
primarily through its direct sales force, as well as through distributors and retail
partners.
#
This two+tiered distribution approach is a more effective way to help the
company satisfy the order e&pectations of a wide variety of customers.
ualitati!e Analysis
Porter"s #i!e #orces
Largaining power of Suppliers
The bargaining power of suppliers in Cisco*s industry is low. ,s a powerful buyer in the
industry, Cisco has been able to pick and choose among the various suppliers who dearly
want Cisco*s business. To ensure suppliers ability to meet the company*s technology,
manufacturing, volume, quality and delivery needs, Cisco has dramatically reduced the
number of their suppliers.
2
!or e&ample, in early #$$ Cisco had nearly ,7$$ suppliers,
with '$) of its purchases focused on appro&imately #$$ suppliers. Currently, the
company has about %7$ total suppliers and spends G$) of our overall e&penditures with
$
Crunching the number.

Cisco Systems.Inc. #$$% ,nnual 3eport. Cisco Systems. #$$% ,nnual 3eport. 3etrieved :ct.#D, #$$%.
#
Ibid.
2
Takahashi, 4ean. /Crunching the Aumber.1EAov. #$$(F ?lectronics Supply and @anufacturing.
3etrieved Aov. #%, #$$% from http;<<www.my+esm.com<show,rticle.8htmlBarticleI4C7#$#(2%
G2 suppliers.1
(
The decrease in the number of suppliers has also reduced Cisco*s reliance
on their suppliers. Lecause of this, the bargaining power of suppliers is low.
Threat of new entries
The barriers to entry into the networking communication equity industry are e&tensive
capital e&penditures and advanced technology. In addition, a large economy of scale has
allowed dominant players like Cisco to operate efficiently over a wide geographic area.
The start+ups in this industry are usually smaller companies attempting to compete in a
niche market, and these companies generally do not have the same economics of sales as
Cisco does in production and distribution. These smaller innovative companies will then
often be acquired by the bigger players. ,lso, the huge capital investment in 3>4
necessary to be competitive in this industry makes it difficult for new entrants to adapt to
the rapidly changing technologies.
Threat of Substitutes
Threat of substitutes is low for Cisco. Cisco has a wide array of products and services to
meet the different needs of their customers. Cisco has also kept a careful watch what their
competitors are doing and they have the ability to quickly produce similar products with
better features than their competitors. Therefore, continuous improvement on products
and services is crucial to Cisco*s business operation.
Largaining .ower of Luyers
Largaining power of buyers is moderate. Cisco differentiates itself from its peers by
providing innovative products and high quality services. Cisco*s key customers are
enterprise customers and telecommunication carriers. ,s the telecommunication industry
continues to consolidate, the bargaining power of carriers will most likely increase.
Therefore, Cisco should maintain a good relationship with the buyers and develop more
innovative products to keep their customers delighted.
4egree of 3ivalry
The degree of rivalry is moderate. Cisco*s primary competitor is Muniper Aetworks
EMA.3F in its core market, which is an end+to+end networking solution. Muniper Aetworks
is /nicely positioned in the telecom carrier market and has been chipping away at CiscoKs
market share.
7
4espite this market intrusion, Cisco has a larger customer base and
stronger capital resources to e&pand their product offerings. /,bout G7) of !ortune 7$$
companies are Cisco*s customers.1
%

2Com, a provider of voice and data networking equipment, is better positioned to tap
Cisco*s domination in the Chinese market, and they recently bought out the profitable
Chinese Moint venture with Juawei.
D

(
Luyers link hands with designers. Carbone, Mames. E@arch. #$$%F. 3etrieved Aov. #D, #$$% from
http;<<www.purchasing.com<article<C,%2722$.htmlBindustryidC#(G
7
@cclure, Len. /Cisco vs. Muniper1. The motley fool. EMun. #$$(F 3etrieved Aov. #D, #$$% from
http;<<www.fool.com<news<commentary<#$$(<commentary$($%$Gbm.htmB
sourceCeptyholnk2$2$$>logvisitCy>npuCy>bounceCy>bounce#Cy
%
ibid.
The competitors that Cisco faces in the niche solution market are ,vaya and Aortel.
Cisco competes closely with them in the ?nterprise -oI.E-oice over the Internet
.rotocolF market.
Stock per$ormance
,s shown in ?&hibit 2, Cisco*s stock outperforms the S>. 7$$ and the large+cap
technology companies through all of !" #$$%. The 7# week range of the stock price is
between 9%.'D and 9#(.D'. ,fter hitting its lowest price of 9D.$ in ,ugust #$$%,
Cisco*s stock began to recover in September and has e&perienced significant growth over
the past three months. Stock prices increased by 9#.$7 the day after Cisco announced its
strong H$D financial results. In Aovember #$$%, Cisco*s board authoriNed up to 9D
billion in further repurchases of its common stock in addition to the remaining authoriNed
amount of 92. billion.
'
This move will enhance their shareholder stock value.
Therefore, the stock price should continue to outperform its competitors as well as the
S>. 7$$ for the near future as the company maintains its healthy growth.
Exhibit %
#inancials
E3efer to ,ppendi& ,F
D
Chen, shu+ching. 2Com*s big China -enture. 3etrieved Aov. #$,#$$% from
http;<<www.forbes.com<#$$%<<#G<2com+huawei+merger+biN+c&=s8c=#Ghuawei.htmlBpartnerCyahooti&
'
Lusiness Iire Aews. Cisco authoriNes up to 9D billion in additional stock repurchases. EAov. #$$%F
3etrieved Aov. D, #$$% from http;<<news.moneycentral.msn.com<ticker<article.asp&B
!eedCLI>4ateC#$$%7>I4C%#$#D7>SymbolCCSC:
.rofitability
.rofit margins in !"$(, $7 and $% were G.G%), #2.7) and G.7G),
respectively. .rofit margin decreased 2.7%), while sales increased by #.27) to
(.'7) from !"$7 to !"$%. The decline in profit margin in !"$% was due to the
acquisition of Scientific+,tlanta, which has smaller profit margin than Cisco.
3:, declined () from !"$7 to !"$% as a result of decreasing profit margins,
while 3:? did not decrease as much as the 3:,, which e&perienced only a
slight decreased of .7). Aevertheless, both the 3:, and 3:? were still
higher than the industry average of 2.') and #.%).
G

!inancial Condition
Cisco does not face any short term liquidity and long term solvency problems. :perating
cash flow to current debt ratio was relatively stable and high over the past three years.
Cisco has e&perienced stable current ratios during the three+year period at a level in
e&cess of .$, with the quick ratios following the same trend.
The long term debt to equity ratio in !$% was $.#%. The company issued si& billion long
term debt in #$$%, which was a radical move considering that they incurred no long term
debt during the past four years. :perating cash flow has been in an upward trend. In !"
$(, $7 and $%, operating cash flow was %.G%, D.7D and D.G$ billion, repetitively. The
company has maintained D.7 billion in cash and cash equivalent as of Muly, #$$%.
Since Cisco is quite financially sound, its significant increase in debt indicates that the
company intends to e&pand its business while trying to place its self in a favorable
position from a ta& deduction standpoint.
Capital e&penditures
Cisco*s e&penditures for !"$(, $7 and $% were 2.#G, 2.2# and 2.(( billion, respectively,
which has been rather flat over the past three years as the company outsourced its
manufacturing with contract companies and did not invest heavily in facilities. Cisco is
likely to continue implementing this strategy as it e&pands business in India in the near
future. Therefore, capital e&penditures should not increase significantly in the near future.
3esearch and 4evelopment
Cisco has a long term commitment to ongoing research and development. In !" #$$%,
Cisco invested more than four billion in 3>4, which represents (.2) of total net sales.
3>4 e&penses for !" #$$% increased by $.G) from !" #$$7.
Iith enhancements to their core routing and switching product lines, introduction of
three new advanced technologies, and ongoing development on several emerging
G
Cisco Systems, 6ey 3atios. 3etrieved Aov. #7, #$$% from
http;<<moneycentral.msn.com<investor<invsub<results<compare.aspB
.ageCInvestment3eturns>SymbolCCSC:
technologies, we anticipate that Cisco will continue their investment in 3>4 in fiscal
#$$D to support their vision of innovation.
#$
uantitati!e analysis
a. 3elative valuation comparison
Exhibit &
,s shown in ?&hibit (,
Cisco has the biggest
@arket Cap among its
direct competitors. Initial
screening indicates that
Cisco*s operating
margins and earnings per
share are the highest in
the industry. In contrast,
the tailing .? ratio is the
lowest compared to
,vayaE,-F and
MuniperEMA.3F. Jowever,
we believed that it may
not be advisable to
simply conclude that
Cisco is undervalued
based on the low tailing .? ratio. Therefore, a second comparison was conducted. Since
Cisco significantly outperforms ,vayaE,-F and AortelEATF in terms of sales growth and
profitability, we eliminated these two companies from our second comparison.
,s Cisco*s ma8or competitor, Muniper has a @arket Cap that is much smaller than
Cisco*s. Jowever, sales growth and gross margin seemed to be higher than Cisco*s.
0nfortunately, high gross margin does not yield higher profit as much as net profit
margins do. To identify which company generates higher profit and better return to
shareholders, key financial ratios were compared in ?&hibit 7.
Since Muniper was delinquent in its regulatory filings for !"$% due to its back+dating of
stock options problem, financial information for !"$% was available. Therefore, we
compared the !"$7 financial ratios for both companies.
,s indicated in ?&hibit 7, Cisco*s profit margin
was #2.7), which was 7.'7) higher than
Muniper*s. The difference in profit margin indicates
that Cisco has a more competitive advantage over
Muniper. 3:,, 3:? and 3:C for Cisco are four
times better than Muniper*s which means that Cisco
is more efficient in squeeNing higher profits from
its assets, generating more value to its
#$
Ibid. pg $.
CSC' A( )*P+ *, Industry
Market Cap- 1.2/00B 1/23B 12/3%B 0/22B 143/%2M
trly +e! 5ro6th 7yoy8- 2&/039 1/239 2./239 14/&39 22/339
+e!enue 7ttm8- %3/12B 1/11B 2/12B 11/32B 20/1.M
5ross Margin 7ttm8- .1/&.9 &./&%9 .2/219 %2/.&9 &0/&49
EBI,:A 7ttm8- 0/24B .%./%%M .14/.1M 1.4/33M 434/33;
'per Margins 7ttm8- 2&/009 4/1%9 23/129 <1/349 <./329
*et Income 7ttm8- 1/0%B 231/33M %1&/%.M <2/21B <&10/12;
EPS 7ttm8- 3/01 3/&2 3/10 <3/11 *=A
P=E 7ttm8- 22/21 20/0% %./14 *=A &3/.2
PE5 71 yr expected8- 1/24 1/20 1/10 *=A 1/10
P=S 7ttm8- 1/&% 1/1% 1/10 3/2& 2/%2
Enterprise (alue=EBI,:A
7ttm8%-
11/10% 4/43% 14/2& ../4%
Source: MSN Money& Yahoo Finance
Exhibit 1
CSCO JNPR
Pro$it Margin 2!15% 1"!20%
+'A 1#!90% $!$0%
+'E 2$!%0% 5!10%
+'C 21!50% 5!00%
Source:MSN
Money
shareholders, and getting better returns to pay its cost of capital. In terms of .ricing+
earnings, Cisco trades at #'.#7 times its #$$7 earnings, while Muniper trades at a lofty 77
times.
#
Simply put, /Ligger, stronger, and cheaper, Cisco is the better buy1.
##

b. 4C! -aluation
To estimate the value of Cisco*s stock price, a 4C! valuation was conducted. ESee
,ppendi& ? for detailsF. The following are the key assumptions in the model;
Ie based our assumptions on historical information and H$D financial results as
well as financial guidance provided by the company.
The three+year average of sales growth is (.D). :ur top+line growth rate
increased to %) for !"$D and !"$' as an indicator of Cisco*s sound H$D
financial performance. Ie used the historical rate of (.D) in the intermediate
high growth period Efrom #$$G+#$F, then $), ') and %) for the declining
growth period. The terminal growth rate is ().
Cost of Ooods Sold EC:OSF as a percentage of revenue is on an upward trend with
an annual ) increase over the past four years. Ie increased our C:OS percentage
) each year for the coming five years. In the declining growth period, we
estimated that because the company now has more of its products outsourced in
India, C:OS as a percentage of revenue should decline to 2%) over the ne&t si&
years and remain at 27) thereafter.
SO >, e&penses fluctuated over the past four years. The historical average rate was
#(.77). Ie increased SO>, e&penses at an annual rate of ) for the incoming
five years, assuming that the company would increase its headcounts in India in the
future. SO>, as a percentage of revenue should decrease the declining growth rate
as the company takes advantage of India*s low+cost labor.
Aet .>? as a percentage of revenue e&perienced decrease on a year+over+year base.
Aet .>? as a percentage of revenue in !"$(, $7 and $% were (.G#), 2.2G) and
#.$'), respectively. Therefore, we used $) Aet .>? rate in the short run and
G) thereafter.
Lased on the above assumptions, our 4C! arrives at a value of 927.77 from the !C!!
model and 92(.2$ from the !C!? model, assuming a () terminal growth rate and a
G.(G) weighted+average cost+of+capital. ,s of 4ecember , #$$%, Cisco has been trading
at 9#%.%G, which is undervalued. E,ppendi& !F
+ecommendation
Cisco*s H$D reflects that they have out+performed their competitors in every product
line across the regions. Cisco will continue to grow through acquisition and the
introduction of new technologies. Iith a strong financial position and sound business
performance, we are optimistic that its stock price will continue outperforming both the
industry and S>. 7$$. Therefore, we recommend adding an additional D$ shares to the
current holdings in our .S0 portfolio.
#
@cclure, Len. /Cisco vs. Muniper1. The motley fool. EMun. #$$(F 3etrieved Aov. #D, #$$% from
http;<<www.fool.com<news<commentary<#$$(<commentary$($%$Gbm.htmB
sourceCeptyholnk2$2$$>logvisitCy>npuCy>bounceCy>bounce#Cy
##
ibid.

Appendices
Appendix A ;ey +atios
233. 2331 233&
Pro$itability
.rofit @argin G.7G) #2.7) G.G%)
,sset Turns $.D( $.D $.%
3:, #.G$) %.G$) (.$$)
3:? #2.2) #(.') G.#)
#innancial Condition
#$$% #$$7 #$$(
operating cash flow to current
debt $.D$ $.'$ $.'$
current ratio #.7 #.' .7
Huick ratio #.#D #.2 .%7
5+T 4ebt<?quity ratio $.#% $.$$ $.$$
Appendix B Income Statement
Annual Income Statement (Values in
Millions) Jun-0 Jun-0! Jun-0" Jun-0# Jun-0$
&a'es $%&"%"'00 $"&%0('00 $$&0"!'00 (%&%)%'00 (%&*(!'00
Cost of &a'es 9(""!00 %(10!00 #(919!00 5(#$5!00 #(902!00
)ross *perating Profit (%&)")'00 (&)('00 (!&($'00 (#&$##'00 ($&0(#'00
&e''ing( )enera' + Admin
E,pense
"(200!00 5(#%0!00 5(9"!00 $(%1%!00 $(%%2!00
*t-er .a,es /A /A /A /A /A
0esearc- + 1e2e'opment $0#"!00 22!00 192!00 15!00 $$%!00
*t-er *perating E,penses( .ota' 0!00 0!00 0!00 0!00 0!00
Unusua' E,pense 34ncome5 91!00 2#!00 !00 $!00 #5!00
E64.1A "%9!00 "#$!00 #5$!00 52"#!00 #1%!00
1epreciation + Amorti7ation 9!00 22"!00 2$2!00 9$!00 #99!00

E64. **'0 )"('0 $*$'0 "%%$'0 $*(*'0
4nterest 4ncome #0"!00 552!00 512!00 ##0!00 %95!00
)ain 38oss5 on &a'e of Assets 0!00 0!00 0!00 3520!005 0!00
*t-er( /et 0!00 #%!00 1%%!00 39!005 3110$!005
Pre9ta, 4ncome )##'00 %0#'00 **$'00 !0(#'00 $)(0'00
4ncome .a,es 205!00 2295!00 202$!00 1$5!00 %1"!00
4ncome After .a,es 55%0!00 5"$1!00 $9#%!00 5"%!00 1%9!00
&pecia' 4ncome:C-arges 0 0 0 0 0
/et 4ncome from Cont!
*perations
5(5%0!00 5("$1!00 $(9#%!00 (5"%!00 1(%9!00
/et 4ncome from 1iscont! *pers!
/et 4ncome from .ota'
*perations
5(5%0!00 5("$1!00 $(9#%!00 (5"%!00 1(%9!00
/orma'i7ed 4ncome 5(5%0!00 5("$1!00 $(9#%!00 (5"%!00 1(%9!00
E,traordinar; 4ncome
0 0
35#"!005
0 0
4ncome from Cum! Eff! of Acct!
C-g! 0 0 0 0 0
4ncome from .a, 8oss
Carr;for<ard 0 0 0 0 0
*t-er )ains 38osses5 0 0 0 0 0

+otal Net Income !&!%0'00 !&)"('00 "&"0('00 #&!)%'00 (&%*#'00
Appendix : Cash #lo6
Appendix E :C# (aluation #orecast
Appendix # :C# (aluation