Why does the market care so much about Cisco's security biz?

In the land of decline, sustainable growth is king


Analysis Like many enterprise tech dinosaurs, Cisco has clutched at new lines of revenue for some time, positioning its security arm as the centrepiece of a long-talked-about reinvention as a software biz.

So when Switchzilla reported lacklustre growth in security of 3 per cent to $558m (£433m) for its fourth quarter results this week, the stock market was quick to punish the business by wiping 2.5 per cent off its market capitalisation.

Security had been one of the few major sustained growth areas, with the full-year result for that side of the portfolio up 9 per cent overall to $2.1bn.

Cisco has certainly splashed the cash to buy its way into the space: when it bought real-time network behavior monitoring startup Observable Networks, Rob Salvagno, Cisco's head of M&A, said the deal "supports Cisco's strategic transition toward software-centric solutions." That buy was on top of a flurry of acquisitions in recent times including OpenDNS for $635m, Lancope for $453m, and CloudLock for $293m.

In reality, security remains a tiny portion of its business, still dwarved by switching and routing, which both declined by 9 per cent, representing $3.4bn and $1.9bn of sales respectively for the quarter. That means Cisco still has a long way to go if it is to rebalance revenues.

Patrick Moorhead, president of analyst firm Moor Insights & Strategy, said Cisco's claims of being the number one enterprise security vendor are justified. But he says US firm will need to ramp growth significantly in the next two quarters to maintain credibility in its plans.

“Strategically there is an absolute link between the network and security," he said. According to Moorhead, security runs throughout the business, including Cisco's infrastructure IoT offerings.

“There is a huge opportunity for Cisco, while we are waiting for the market to mature in areas such as self driving cars and automated factories," he said.

Traditional spend

Though the old world networking market might be in decline, Cisco still accounts for up to 80 per cent of global sales - so it is arguably in a better position than some other vendors set up before the age of the cloud.

In the company's earnings call, chief exec Chuck Robbins identified low federal spending, poor currency rates in the UK and a sales backlog as contributing to a fall in its traditional business. He said the company "had anticipated" a pause in switching.

Indraneel Arampatta, analyst at Megabuyte, believes the traditional networking business will eventually start to plateau, but said he does not expect that to happen in the next year.

He said: “I do take security as a bit of a guiding point, as it indicates the software and recurring revenue part of Cisco’s strategy.

“Currently security software is going through a massive growth phase, due to increased company awareness, high profile attacks and regulatory changes such as GDPR. So with that in mind, this quarter's revenues seem somewhat disappointing.”

However, Cisco's recurring revenue reached 31 per cent of total revenue for the quarter, up four per cent year-on-year, something Arampatta said was an encouraging sign.

“When it gets to 50 per cent that will be an important milestone, although I couldn’t say when that will be. It has certainly taken Cisco a lot longer than it had hoped to get to this point.”

Pleasing Wall Street?

Some commentators have remarked that it is in Cisco’s interests to pay lip service to the stock market and investors by strongly emphasising its software strategy, as that is an area that tends to yield much higher margins than the traditional hardware business.

Tony Lock, analyst at Freeform Dynamics, is one such sceptic. “Software is something it has to talk about prominently to keep accountants happy,” he said.

“There are natural buying cycles which could account for the steep full in its traditional networking. But hardware is not going away, SDN has to run on hardware somewhere. And the core backbone of its business relies on dedicated switching in the vast majority of instances. Of course software is more important, but the days of the hardware network are not over.”

For Moorhead, security, IoT and SDN remain the crucial success indicators for Cisco if it is to achieve sustained growth in the long-term. It will become apparent in the next two quarters whether Cisco will be in a position to achieve that, he said.

New World Order

In a market where decline and diminishing returns have become the norm for many in the industry (IBM last month posted its 21st quarter sales drop), Cisco this week reported its seventh conseuctive quarter of negative growth.

"One of the reasons for its comparatively late falling sales, is that enterprise networking is so sticky," said Moorhead at Moor Insights & Strategy. "You can't just rip it out like you can with storage and servers. Changing the network is much harder."

Moorhead boils it down to the fact that every single incumbent enterprise business is facing the challenge of selling the "new stuff" (cloud, open source, software-defined products) at a higher rate than "losing the old stuff" (proprietary, command-line interface, resource heavy services and hardware).

“So far none of the traditional enterprise players have been able to say 'we’ve turned a corner for sustained growth'. An industry turnaround might be forthcoming in the next three years, he said. But that will be driven by the maturation of the on-premise cloud stacks.”

Might be worth bearing this in mind when Cisco, or any of the other old world protagonists, knock on your door with advice about that much-discussed digital transformation journey effort. ®

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