Nightmare In Networking, IBM Sniffing Around

Yesterday Cisco, the networking giant with annual revenue of $39.5 billion, reported a mixed third quarter that beat analyst expectations even as profits and sales declined. Like its rival Juniper, Cisco saw signs of stability in the industry.

Q3 net sales declined 17% to $8.2 billion. Net income declined 24% to $1.3 billion or $0.23 per share. Non-GAAP EPS was $0.30, beating analyst estimates of $0.29 on revenue of $8.07 billion. Deferred revenue was $8.8 billion at the end of the quarter, down from $9.3 billion at the end of Q209.

Non-GAAP gross margin was about 55%. The company generated $2.0 billion cash in the third quarter, compared with $3.0 billion last year. It ended the quarter with $33.6 billion in cash. During the quarter, Cisco bought back shares worth $1.2 billion and is left with $5.6 billion in authorized repurchasing funds.

As for orders by regions, US orders in Q3 were down 20%. Japan was down 20% and Asia Pacific 27%. China was down in the high single digits while India was down over 30%. European markets were down 28% and in emerging markets, not counting emerging markets in Asia, orders were down 31%.

Switching revenue was down 20% to $2.6 billion. Routing revenue was down 32% to $1.4 billion. Advanced Technologies revenue was down 12% to $2.1 billion. Within Advanced Technologies, Video Systems declined 5%, Unified Communications 7% and Security 14%.

As we expected last quarter, Telepresence was one area that had a strong third quarter with 70% order growth, revenue growth of 130%, 45 new customers and approximately 400 new system orders. Cisco now has six customers with 50+ telepresence systems deployed and a total of more than 300 telepresence customers.

Cisco expects total revenue for the fourth quarter to be down 17-20%. Gross margin is expected in the range of 63% to 64%. In the earnings call, CEO John Chambers discussed how the industry is showing signs of stabilizing. He added that “no one knows how long this leveling out will last or whether it will result in an upturn several quarters from now.” Cisco is preparing for the upturn with its move into adjacent markets. Its focus is now on video, collaboration, data centers, virtualization and globalization, and its recent acquisitions reflect that.

Cisco recently announced plans to acquire Pure Digital, creator of the Flip Video, and Tidal Software, a creator of intelligent application management and automation solutions to complement its data center strategy. Further, it completed the acquisition of Richards-Zeta Building Intelligence, Inc., a leading provider of intelligent middleware technology.

A major announcement from Cisco this quarter was its Unified Computing System, which has set in motion the acquisition spree in the industry. We had speculated about Brocade and HP joining hands against Cisco’s data center plans. However, it is IBM who has partnered with Brocade. Cisco is currently trading around $19 with a market cap of about $115 billion. The stock hit a 52-week high of $19.93 on April 30.

Another networking company that has observed that the economy is stabilizing is Cisco’s main rival, Juniper Networks. This is even as Juniper swung into a loss and missed estimates. On April 23, it reported a weak quarter with Q1 revenue of $764.2 million, down 7%. Net loss was $4.5 million or $0.01 per share, compared with net income of $110.4 million, or $0.20 per share last year. Analysts expected profit of $0.17 per share on revenue of $764.4 million.

Gross margin declined to 64.9% from 67.8% lat year. Operating margin declined to 10.6% from 17.3%. Juniper generated net cash from operations of $163.9 million, compared to $254.9 million last year.

For Q2, Juniper expects revenue of $740 to $780 million and non-GAAP EPS of $0.16 to $0.18. Analysts are expecting revenue of $773.6 million and EPS of $0.18.

Juniper is currently trading around $23 with market cap of about $12 billion. The stock hit a 52-week high of $23.11 on May 5.

Juniper is a strong competitor to Cisco, and IBM seems to be aggressively pursuing an anti-Cisco strategy by expanding its relationship with Juniper in addition to that with Brocade. Earlier in my networking series, I speculated about the consolidation of the networking dwarfs against giant Cisco, and IBM seems to be putting some of them together against Cisco, albeit in a loose coupling mode.