Why Cisco Investors Should Be Patient

NEW YORK (TheStreet) -- Shares of computer-networking giant Cisco (CSCO) have fallen 12% during the past nine months even though the company has beat earnings estimates for 10 quarters in a row. It will report earnings for its fiscal third quarter on Wednesday.

Analysts and investors are taking a wait-and-see attitude before going all in on the company's turnaround plans. Shares closed Monday at $23.19, up 5% year to date.

In December, citing a lack of visibility into the economy, CEO John Chambers cut the low end of the company's revenue growth estimates for the next three to five years from 5% to 3%. That spooked investors because it was the first time in three years the company had reduced its long-term outlook.

And in February, Cisco reported a 7.8% drop in revenue for its fiscal second quarter and delivered its lowest product gross margin (58.8%) in more than a decade.

There are now concerns that Cisco is losing market share to (among others) Juniper (JNPR) and F5 Networks (FFIV). Investors, however, should realize that the entire sector has underperformed because of shrinking corporate budgets. 

Cisco has countered by discounting some of hardware, which pressured margins. The margin numbers were tough to stomach. But there is plenty of untapped value here. 

Consider that even with its recent decline in revenue, Cisco reported second-quarter earnings per share of 47 cents excluding items, a penny better than analysts' estimates.  The company also raised its quarterly dividend to 19 cents a share from 17 cents.

But with Wall Street's quarter-to-quarter obsession with growth, that performance wasn't enough. And that is where Cisco's management must convince a jittery market that the company's long-term plan remains intact. It starts Wednesday. 

Wall Street will be looking for earnings per share of 48 cents on revenue of $11.38 billion, which would represent a year-over-year revenue decline of 6.8%. But a decline would hardly be a surprise. Cisco -- which has always had a dominant market share in routers and switches -- has struggled amid the arrival of cheaper software.

Router and switches, which direct Internet traffic, account for almost half of Cisco's revenue. Meanwhile, businesses are shifting to cloud computing and are outsourcing their networking needs. That means corporations no longer need to build their own data centers, which was once the driving source of Cisco's growth.

Management's job is to find new growth areas before the legacy business come to screeching halt. To that end, management has outlined several strategies to boost long-term profits, including using Cisco's strong cash position to make significant acquisitions. Purchases have included Meraki, Cariden and Broadhop as well as anti-hacking giant Sourcefire (FIRE). The moves were done to offset the slow-growing hardware business. 

Cisco is a high-quality company trying to deal with soft corporate technology spending. Investors should management time to execute a turnaround.

With shares trading at around $23, I project fair value to reach $26 in the next six to 12 months on the basis of earnings-per-share and long-term revenue growth.

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At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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