In part one of this article, we discussed the importance of networking companies - namely Hewlett Packard (HPQ), F5 (FFIV) and Juniper Networks (JNPR). The premise of the article involves the return of technology spending and where large corporations are most likely to spend their money. The first obvious choices are on the companies that specialize in managing data traffic - essentially the lifeblood of most operations. Here are four more to consider.
Cisco (CSCO)
For quite some time now, Cisco has been considered the gold standard among that group. However there is reason to suspect that the competition for that title is no longer a foregone conclusion. However, I am inclined to look at the entire sector to start to appreciate a little bit more of what each company has to offer in their own right.
In its most recent quarter which ended January 28, Cisco reported net income that climbed 44% and arrived at $2.2 billion, or 40 cents per share. This compares with earnings of $1.5 billion, or 27 cents per share year-over-year. If you factor out that the costs associated with stock-based compensation as well as some acquisition-related amortization, the company actually earned 47 cents per share - 4 cents per share above analysts' expectations based on polls by FactSet. Revenue was $11.5 billion, up 11% from $10.4 billion a year ago and compares favorably to the $11.2 that was projected.
I think that is what analysts continue to ask. As impressed as I am with the report, there continues to be many who are simply unwilling to give the company much (if any) applause for what continues to be a remarkable turnaround from the depths of last summer where Cisco showed little focus whatsoever. Its results clearly demonstrate the company is keen in improving its margins as it reported gross margin that improved a full point from the previous year while also exceeding analyst estimates. However it seems that area of performance is not growing at a rate that appeals to the most ardent bears - at least to the extent where it can prove that it can reclaim some of the market share that it has lost to the competition over the years.
Brocade (BRCD)
Brocade is another interesting story and one that I have recently become enamored with. In its recent Q4 earnings announcement, not only did it beat its projected numbers but it also raised guidance. The question is though, what did it prove? But that is not to take away from the many accomplishments that it has logged this year, especially considering the market's early reaction to its once perceived inability to compete.
Looking at it from a bearish lens, Brocade's Q4 numbers were far from stellar. The company reported flat revenue on a year-over-year basis and less than 10% sequential. Revenue for its network storage service was down 4% from the previous year, but this was offset with an 11% growth from smaller areas of its business - notably IP. But regardless of how one looks at it, it can't be discounted that it did beat consensus estimates on both year-over-year declines and its end of range. To top it off, profitability was a huge plus.
In 2008, the company acquired one of its competitors, Foundry Networks. That was an acquisition that seems to now be paying off. In the deal, management sought to broaden the company a little bit more and place less dependency on its storage business. The other advantage was it wanted to be able to sell networking gear to its existing customer base to provide the services of a one-stop shop, a strategy that is now proven to have worked or at the very least, currently working. Brocade continues to prove that it can do just fine with a small piece of the market pie for now, but there is no denying that it is hungry for a bigger slice.
Alcatel-Lucent (ALU)
It appears that there is modest recovery in communications spending for this reason. Things are starting to look more favorable for two the sectors recent underperformers in Alcatel-Lucent and Ciena. Although it is hard to tell of late, the IP and optics businesses for both companies are looking better as well - particularly for ALU. The company's newest routing platform competes extremely well when compared to similar models from Cisco as well as Juniper. Some experts have suggested that it might (in fact) be slightly better.
The company is also seeing an uptick in its wireless segment business and ALU desperately needs this trend to continue. The company has shown that it is not restricted solely to U.S. business as it has managed to get contracts from the three major Chinese service providers in China Mobile, China Telecom and China Unicom. This is even though competitors Huawei and ZTE are prominent and local. This is nothing short of remarkable. These are not small deals either, and ALU's partnership with China Mobile for a next-generation network could pay large dividends in the years to come.
In the U.S. the company has forged deals with the major carriers such as AT&T (T) and Verizon (VZ) and they continue to spend large sums of money to upgrade and expand networks. As great as that is, I am intrigued to find out how much margin ALU can draw from this business.
Ciena (CIEN)
Optical networking firm Ciena is one company that I've had my eye on for quite some time and I think that it may be time that other investors do that same. Though its name is seldom mentioned among the ranks of Cisco and HP, the company deserves a considerable amount of credit for (if nothing else) the fact that it still exists today. While some consider Ciena a product of the tech bubble, the company did not actually enter any legitimate discussion until the bubble had already burst. In similar fashion, the end of the bubble sent many of its clients out of business as many of them over-spent on networking equipment.
So this is where the company still ranks today - at the bottom of the list when it comes to the top networking names in the sector. But it does appear to now have a few things working in its favor. Its recent quarterly performances suggest that management has figured out ways to squeeze more margins out of its products. But analysts continue to question whether or not its recent performance is sustainable.
For this reason, I continue to have my own doubts about the company and I'm not yet ready to proclaim that it is a buy just yet. What remains to be seen is whether the company has the ability to produce a second act of profitability and growth. It would need to demonstrate this over a period of (at least) three consecutive quarters for me to feel comfortable that it can run its business effectively. But as prudent as that may be, by then everyone may have figured it out. It's a double-edged sword where risk is the means of profitability. But investors may want to consider some of the names above in anticipation for when technology spending fully returns.
Disclosure: I am long CSCO.
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