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By Erik Kobayashi-Solomon | 06-21-2011 12:19 PM

Cisco's Journey Between Growth and Value

Analyst Grady Burkett on Cisco's current business challenges, capital allocation missteps, and the evolving change in investor sentiment surrounding the stock.

Erik Kobayashi-Solomon: Hi, my name is Erik Kobayashi-Solomon. I'm one of the editors of Morningstar's OptionInvestor, and today it's my great pleasure to welcome Grady Burkett who is the associate director of technology research here at Morningstar.

Grady, thanks for coming.

Grady Burkett: Thanks for having me, Eric.

Kobayashi-Solomon: So, a couple of months ago, I wrote an options investment piece on Cisco. At the time, you were just transitioning into coverage of Cisco and since then, there have been a ton of things that have happened with the company. Can you just catch us up with some of the big happenings?

Burkett: Absolutely. I initiated coverage on Cisco right as they reported fiscal 2Q, so that was in February, and obviously it was a disappointing quarter. The stock sold off about in the mid-percentages--14%, 15%--on the backs of some disappointing earnings, and more importantly, a disappointing outlook.

Essentially, there are couple of things going on with Cisco. Part of it is weakness in its government business, but probably more importantly there is a weakness in some of its core businesses, where Cisco has been very strong for a long period of time, and so switching in particular is an area of weakness for the company.

Kobayashi-Solomon: But just even aside from what their business has been doing, they also announced their first dividend about that time as well, right?

Burkett: Absolutely. So ... on the back of some of these weak earnings report and weak outlook, you saw management start to engage in some activities that suggest that it realizes some of its issues with size and some of its competitive positioning, and so you saw Cisco on the back of the earnings announcement, introduce a new chief operating officer, Gary Moore, to help realign and restructure the management team. You saw them initiate a $0.06 per share per quarter dividend, which equated at the time to about 1.5% yield or $1.4 billion in annual cash outlays.

Kobayashi-Solomon: The other thing that I did, which was one of our favorites, was they killed Flip. I just couldn't wait for them to kill Flip actually.

Burkett: Right, and when we've looked at the consumer space as a segment that Cisco shouldn't be playing in over the long run, and so they killed Pure Digital. They ... had been developing "umi," which is a home video-teleconferencing service and equipment, that they pulled back out of the consumer space and just reintegrated that technology back into collaboration business.

And so ... these were the initial steps that Cisco started to demonstrate ... after its 2Q results that were positive on the margin.

Kobayashi-Solomon: So, one other things that I picked up, and that I was really happy about, was actually Chambers, the CEO, John Chambers, admitted, "look we're not going to grow at 20% or high-teens percent forever. It looks like our growth is going to be slower." And this is a big admission for him, I think.

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