Cisco Is Getting Squeezed By New Competition

John Chambers

[credit provider=”Associated Press”]

BOSTON (TheStreet) — Cisco’s(CSCO) dominance of the market for computer-data networking has long been unassailable, but a handful of companies are successfully nibbling from behind.They include Hewlett-Packard(HPQ), Juniper Networks(JNPR), Brocade Communications(BRCD), Dell(DELL), Adtran(ADTN) and the privately held Arista Networks.

“Every one of these companies is trying to take business from the other,” Morningstar analyst Gary Burkett said in an interview.

It just happens that Cisco is the industry’s biggest target. The company’s products include network routers and switches, access equipment, and network-management software that allow data communications among computer networks. Cisco has recently entered several new markets, such as video conferencing, Web-based collaboration and data-centre servers by making acquistions.

On the high end of the networking market, Cisco is a tough nut to crack because of its long-standing relationships with many big corporate customers. They’re not eager to switch to a new vendor given the uncertainties and expense involved.

And that’s why Cisco’s share of the enterprise-routing and switching market has remained near 70% for the past five years, Burkett said in a research note. “The status quo is still the first option for mission-critical switch installations.”

Another reason for its hold on the market is that Cisco has proprietary patents and programming source code that others can’t match. But one of the ways competitors are sneaking market share and landing new customers is by releasing their networking products with open-source code, which means independent programmers can develop customised applications for them on the cheap, something Cisco has eschewed.

Hewlett-Packard took a shot at Cisco for that failing in a new initiative announced Monday. Its new FlexNetwork architecture allows companies to run their own network without necessarily locking them into specific vendors.

“Single-vendor, proprietary approaches, such as Cisco’s, lock in customers while driving up cost and complexity with different architectures required at each point in the network, including data centre, campus and branch,” Hewlett Packard said pointedly in a statement.

And Cisco’s dominance is being tested in the low-technology end of the switches and routers market, as customers become increasingly cost-sensitive, and some products and services are becoming commoditized.

“These low-cost competitors could continue to use price as a primary means to compete, which could have a negative impact on Cisco’s margins if the company is not able to continue to innovate and lower its own costs,” said UBS Investment Research, a unit of UBS(UBS), in a May 5 research report.

Those competitors include Dell and Hewlett Packard in local area network switching (LANs) and Hewlett Packard’s 3-Comm unit, China’s Huawei and Adtran, in enterprise-routing systems.

And Brocade Communications, a leader in the storage-switch industry, has recently begun making Ethernet switches, an area where Cisco is also the leader. But it has supply agreements with other server and storage vendors that Cisco doesn’t, such as International Business Machines(IBM), Hewlett Packard and Dell, that will help fuel its growth and keep Cisco at bay.

“In the data-centre space, we expect Juniper and Arista are going to make more inroads,” Burkett said, as Juniper has technologies that are equivalent to Cisco’s in some applications, while Arista makes high-performance switches that work well for sophisticated applications such as financial exchanges where speed and volume are key.

But Cisco remains a potentially formidable competitor. With $40 billion in cash on the balance sheet and an annual free cash flow of about $9 billion, it has shown it is willing to sell on the cheap in markets it wants to rule and has acquired complementary companies in fast-growing industries where it doesn’t already have a presence.

Also adding fuel to the fire, Standard & Poor’s analyst Ari Bensinger says, is that “the industry is undergoing a technology shift toward convergence, where customers require a product platform to offer computing, networking, storage and other applications all in one box.”

So products and services have to become more intertwined and, as a result, companies like Cisco will increasingly find themselves in competition with teams of server, data-storage and computing firms working together.

And that’s going to push companies to aggressively partner or acquire missing technologies going forward, Bensinger said in a May 7 research note.

And that could change the industry landscape and squeeze Cisco even more if it fails to adapt.

The company announced a major reorganization May 5 but that wasn’t enough for Morgan Stanley(MS) analyst Ehud Gelblum who called for the company to be split up into three segments, arguing that its problems are structural as it’s made up of disparate businesses with different growth rates and operating margins.

Another area that Cisco needs to address is its share price.

Institutional investors still own 70% of Cisco’s shares, but their stakes have been trending downward over the past two quarters.

Cisco shares, which have a total market value of $97 billion, are down 13% this year compared to the S&P 500 Index’s 7.2% gain, and off 30% over the past 12 months, compared to the S&P’s 21% rise. More tellingly, the shares have fallen at an annual average of 12.5% over the past three years.

Burkett said he thinks Cisco’s share prices have suffered because many of its long-time growth-style investors have lost patience waiting for a turnaround.

“It will have to find a new investor base. It isn’t going to be growing (revenue) at a 12% to 17% rate anymore, which is why they’re doing things like reorganising,” he said.

And despite all its challenges, “we still think Cisco is a buy right now,” said Burkett.

So, too, the investment firm Sterne Agee, which reiterated its “buy” rating on Cisco May 6. It said investors underestimate the possibility of a turnaround.

And despite the cut-throat competition, Cisco and others in the industry are expected to see healthy growth due to the demand for their products as voice, video, and data networks converge toward Internet Protocol, the use of cloud computing grows, and Internet traffic continues to expand by 50% or more per year.

This post originally appeared at TheStreet.