Daily Interview: Where Does Cisco Go From Here?

Cisco (CSCO Quote) announced Friday it would eliminate up to 17% of its workforce through "voluntary attrition, involuntary attrition and the consolidation of some positions." The company also said that a slowdown in capital spending by telecommunication companies could preclude "the so-called V-shaped recovery bulls were banking on."TSC spoke with Michael Cristinziano, senior vice president of equity research at Gerard Klauer Mattison about the significance of the news for Cisco and what it means for the widely held position that the U.S. economy will strengthen in the second half of the year.

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TSC: How is Wall Street taking the news that Cisco will cut between 5,500 and 8,000 of its full- and part-time workforce of 48,000? Will investors view this as a positive cost-cutting measure, or will they instead focus on the fact that Cisco is experiencing slower sales in Europe and Asia than anticipated?

Cristinziano: The fact that Cisco -- which has hired 3,000 to 4,000 people for the past few quarters -- foresees a worldwide slowdown in networking demand necessitating a significant cutback in their workforce is disconcerting.

This appears to be a severe slowdown that will be viewed negatively. Even though Wall Street always loves cost-cutting measures, this reduced headcount is less of an earnings-improvement measure and more of a serious, symbolic statement about a worldwide slowdown in sales that Cisco is making to the investment community.

As recently as November, Cisco seemed to have some visibility and confidence and they weren't taking any type of cost-cutting action. The fact that they have turned around with this dramatic declaration is a concern. My sense is that even Cisco is proving it's not immune from the earnings misses in tech.

However, we still have to see how quickly Cisco handles these cuts and whether they reach the high range of 17% [of projected layoffs], what number are through attrition and how many full-time rather than part-time workers are affected. If it turns out to be on the severe side, it surely says something about the demand that's out there.

One way to put a bullish spin on this is this: You could say that these severe cuts are just a natural extension of Cisco's aggressive acquisitions, that the company is using an economic slowdown as an excuse to weed out the dead wood. You don't get to interview every employee when you make an acquisition.

TSC: Do you view this as another indication -- currently, a minority opinion but one that nonetheless is being voiced -- that the U.S. economic slowdown may be spreading to the rest of the world?

Cristinziano: Either Cisco is really seeing a worldwide slowdown, or they are listening to some of those economists. It's hard to say which is true. I haven't talked to [Cisco CEO] John Chambers about it.

TSC: What, if anything, can Cisco do to improve sales?

Cristinziano: There really isn't much that Cisco can do, because in spite of its rocket-ship rise, it's just not immune to the backlash in technology that's followed the dot-com frenzy, the weakened U.S. economy, the Y2K fallout and the tough year-over-year comparisons that all technology companies now face.

As long as the news out of techland remains negative in downward earnings revisions, I don't see shares of Cisco or other companies rebounding. Honestly, I have been wrong on Cisco. I have been saying how cheap it was at $38, and here it is at $20.

TSC: What indications will you be looking for, then, for Cisco to move back into positive territory?

Cristinziano: Cisco apparently had poor visibility on the downturn, and it's possible the company will have poor visibility on the upturn. This uncertainty will weigh on the shares for the foreseeable future.

The stock will not begin to retrace its monstrous climb of the past three years until we get an offsetting event out of the company. We won't hear the company announce a 17% expansion of its workforce anytime soon. But what we could get is a John Chambers at a conference, at an analyst meeting or on a conference call, in a Greenspan-esque way say we are beginning to turn the corner.

In the meanwhile, I'll also be looking to see if Cisco eliminates as many as 17% of its jobs. I need to talk to Larry Carter [Cisco's chief financial officer] to get a better handle on how they are going to go about this reduction. Only then can I or other analysts come up with new earnings estimates. Those estimates are likely to cover a wider range, given the uncertainty that not only we, but I think, management have.

While the Internet has happened -- and for companies like Cisco, it's been a phenomenal development -- we keep waiting for the next Internet killer app. It hasn't arrived yet. Video hasn't made it to everyone's desktop. If that had happened a year or two ago, maybe Cisco wouldn't have this problem because the demand for routers that would have created would have been immense.