Maybe talk isn't so cheap after all. Just ask
The maker of devices that link computers together has seen its shares fall 13% this week amid questions over the stock's valuation and the company's massive acquisition slate. Wednesday saw a techwide selloff push Cisco shares down 4 1/4, or 6.8%, to 58 1/2 in spite of a characteristically strong third-quarter earnings report Tuesday.
Investors have long known that Cisco dominates the market for equipment that connects computers. But now they're catching on to the fact that it is scrambling to catch up in a less sexy but equally lucrative area: the market for equipment that enables people to talk to one another. Cisco's earnings report showed sales to telephone companies rose just 15% from second-quarter levels, falling short of many observers' expectations.
Now, having lost out to rival
in a key acquisition, Cisco faces the prospect that weakness in optical transport equipment -- the backbone of next-generation phone carriers -- could further pressure a stock that, at 170 times trailing earnings, is still rather pricey.
As Cisco moves beyond its core business of selling routers, or gear that directs data traffic from one computer to another, it is vulnerable to telco-equipment giants such as
and Nortel. Call it home-court advantage: Phone companies built their networks in large measure using equipment from Lucent and Nortel. And having sunk fortunes into this infrastructure, outfits like
aren't keen on trashing their networks in order to accommodate Cisco's Internet-based technology.
By some estimates, more than 50 cents of every dollar spent on network equipment comes from the established telcos and regional Bell telephone companies.
But Cisco's problems in cracking this market are illustrated by the creation and subsequent dissolution of a joint broadband development group with
and Sprint, called
Together the three companies aimed to design an Internet protocol-based platform that could bridge the voice and Internet world. Sprint found that other vendors could address the problem more effectively than the Cisco group, says a Sprint spokesman.
Cisco's performance with phone-industry customers is shining the spotlight on its strategy in this area.
"That 15% number seems to be on the low side," says
networking analyst Michael Speyer. "They also haven't gained much traction on the optical side, where Nortel seems to be doing particularly well." Yankee consults to all the major communications equipment and services companies.
Indeed, Nortel is the runaway leader in the optical-transport market, while Cisco ranks a distant fourth. Cisco's less-than-10% slice of the pie is actually shrinking, says Dana Cooperson, an analyst at
Ryan Hankin Kent
, a market research firm that consults to all the major equipment makers. The competition in this segment underlines the roster of significant challenges Cisco faces in trying to crack the phone market.
"I think telecom is a harder market to win than a lot of people imagine," says
Giga Information Group
networking analyst Lisa Pierce. "This doesn't mean Cisco can't be successful, but most existing carriers that serve the vast majority of customers have an infrastructure. They aren't going to throw it out -- they're going to be operating for years and years."
The One That Got Away
While much attention has been focused on Cisco's strategy of buying small companies to get its hands on promising technologies, in the optical transport area the biggest deal appears to be one Cisco failed to make. In January, the company lost out to Nortel in a bid to woo long-haul optical player
, says Qtera founder Fahri Diner. Cisco declined to comment on what it called rumors and speculation.
Qtera, which Nortel bought for $3.25 billion, began proving its value Tuesday when Qwest agreed to buy a few hundred-million dollars' worth of Qtera optical gear to light up long portions of its 18,500-mile U.S. network. The Qwest/Nortel contract makes it imperative that Cisco bring something more to the market if it hopes to gain some footing.
"Nortel has always held the high end of the high-speed market and this sort of solidifies their positioning as the player to beat," says Cooperson. "It's clear Cisco wants to play in the long-haul market. The question is whether they'll be able to do it internally ... or externally through another acquisition."
Cisco's new strategy chief and top deal-maker, Michaelangelo Volpi, says that with the acquisition of
, Cisco has long-haul technology. He adds: "We are going to wait and see how large this market segment is going to be and how much in terms of resources we want to invest. If we feel we need to look externally to fill that, we'll do so at that point in time."