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Cisco (CSCO - Get Report) continues to make progress with its shift from hardware to software and businesses with recurring revenue. The company's soft guidance on Wednesday, however, suggests the changes are not coming fast enough to offset challenges the networking giant faces, and raises the question of whether Cisco could make a large acquisition to speed things up.
Total revenue for the fiscal third quarter was $11.9 billion, down 1%, but topping forecasts. Cisco expects revenue to decline 4% to 6% in the fourth quarter, a larger drop than investors expected.
"People could handle a 1% or 2% year-over-year drop," Edward Jones analyst Dave Heger said. "The guidance for a 4% to 6% drop broke out of what the recent trend has been."
Cisco is managing the mature switching and routing business while it develops growth businesses. "A lot of investors fear a sudden drop off in that core part of the business," Heger said.
Businesses with recurring revenue made up 31% of our total revenue from recurring offers, up from 29% a year ago. Cisco is building up its growth businesses, but not fast enough.
"While the performance is encouraging, the transformation could take multiple years to play out and Cisco could look to make a more transformative acquisition to help accelerate the pace," BMO Capital Markets analyst Tim Long wrote in a report on fiscal third-quarter earnings.
Cisco's priorities include the Internet of things and apps, security, the cloud, data center and analytics, and network technology.
Cisco closed the $3.7 billion purchase of network and application monitoring company AppDynamics in the quarter and also announced the $610 million acquisition of networking technology company Viptella and the $125 million acquisition of artificial intelligence platform MindMeld.
"These acquisitions support our goal of offering customers extraordinary value through a combination of organic and inorganic innovation, and they are aligned to our strategy of investing to drive long-term growth and helping us transition to more recurring software and subscription revenue," CEO Chuck Robbins said during the Wednesday earnings call.
Cisco could look for technology it could infuse into its networking business, Heger suggested. "Anything that could further position them for this move towards more of a virtualized networking or software-defined networking," he said.
The Internet of things is another possibility. Cisco acquired IoT platform Jasper for $1.4 billion last year, and Heger suggested that the company could shop around for companies with analytics capabilities that it could apply to the burgeoning array of networked devices. "A lot of the value in the Internet of things lies in being able to crunch and analyze the data that is coming in from devices," he said.
Cisco could have more resources to make acquisitions if the Trump administration can follow through on its planned tax breaks for corporations. The company would fare especially well in a tax holiday on offshore cash, which Trump recently talked up.
Editors' pick: Originally published May 18.
Of Cisco's $68 billion in cash at the end of the quarter, $65.1 billion is offshore.
Jim Cramer and the AAP team noted that Cisco's disappointing guidance came on a day when political turmoil upended the markets, resulting in the worst trading day of the year. "While the quarterly results were solid, showing growth in software, subscriptions, and deferred revenue, the outlook for the coming quarter was meager at best, and commentary regarding macro and global uncertainty spooked investors on a day when investors could not take any more spooking. Get a free trial subscription to Action Alerts PLUS.
With tax reform, Credit Suisse analyst Kulbinder Garcha suggested in a note before the earnings call, Cisco could boost its capital returns by $30 billion over five years and still have $20 billion for the acquisition of a company such as Splunk (SPLK - Get Report) , ServiceNow (NOW - Get Report) and Palo Alto Networks (PANW - Get Report) .
Big data software firm Splunk, with a $9 billion market cap, is Garcha's pick. The company would improve Cisco's exposure to the cloud, Internet of Things and security.
Meanwhile, ServiceNow, which has a $16.7 billion equity value, develops software to manage IT, customer service, human resources, security and other functions. The business would expand Cisco's cloud business, and to a lesser extent, its Internet of things offerings.
And cyber security company Palo Alto Networks, with a $10.5 billion market cap, would obviously add to Cisco's security capabilities.
Cisco declined to comment for this story. ServiceNow declined to comment. Splunk and Palo Alto Networks could not immediately be reached.
The markets will get an update on Cisco's strategy in a little more than a month, when the company holds its Investor Day on June 28.
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