Tuesday, November 27, 2007

Cisco Systems (NASDAQ:CSCO): Color on yesterday's move

Morgan Stanley and Banc of America are out commenting on Cisco Systems (NASDAQ:CSCO) this morning after the stock got hit yesterday on heels of cautious comments from Morgan Stanley on CSCO's Emerging Markets' decelerating growth rates.

Mother Morgan noted yesterday morning that in Cisco's F1Q08 quarterly filing, data for the emerging markets showed a significant deceleration in revenue growth. Specifically, emerging markets revenues grew 19% YoY in the October quarter, down from 35% YoY growth in the August quarter and 36% YoY growth in the same quarter a year ago. The firm said that while they remain confident in their Overweight-V rating and $38 price target, they would closely monitor this critical part of Cisco's growth story for signs of a rebound or further deterioration.

The comments from this morning are the following:

- Banc of America managed to host several Telepresence based meetings with Kelly Ahuja, Cisco's Vice President & General Manager of Core Routing yesterday. According to the firm, Mr. Ahuja indicated that trends in routing remain strong and that increasing broadband penetration and bandwidth consumption will likely drive robust demand for the foreseeable future. BAC believes the company's routing business can continue to deliver mid-teens rev growth for the foreseeable future.

Cisco was confident regarding its position within the emerging markets and stated that developing nations still require Cisco's ability to deliver an end to end network vs. the point solutions offered by competitors. However, due to a lack of existing infrastructure, network rollouts and revenue recognition may lag order growth.

Due to robust traffic growth, Cisco is still seeing good routing demand from larger carrier and enterprise customers, while healthy demand for managed services gives the company confidence that the SMB market remains healthy. Maintains Neutral and $33 tgt.

- Morgan Stanley notes that as a follow up to their Nov. 26 note, they reaffirm their view that underlying fundamentals of Cisco's emerging markets business are intact, and believe revenue growth and gross margins should rebound in FQ2.

A discussion with Emerging Markets head Paul Mountford and Corporate Controller Jonathan Chadwick indicated that EM fundamentals remain strong and that if not for the change in the way Cisco processes deferred revenue, the segment would have turned in growth similar to prior quarters. MSCO notes, however, that order growth did slow from 40% in prior quarters to a still strong 35% YoY in F1Q. This change in deferral accounting is noted in the 10-Q but not fully explained.

While the decline this quarter is a concern and one that bears watching, discussion with management leads the firm to expect a rebound in FQ2 (Jan) to recent levels (~63%) as specific events that impacted FQ1 seem unlikely to repeat in upcoming quarters.

Notablecalls: I think the deceleration in Emerging Markets is for real. I also think we're going to see further deceleration in the US and Europe soon. While today's comments coupled with overall positive tape may generate a bounce, I expect it to be short-lived.

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