Thursday, August 11, 2011

Cisco's Results & Outlook

Troubled Cisco (CSCO) reported some pretty solid quarterly results yesterday.

Reuters:
Cisco jumps as revenue outlook calms investors

Bloomberg:
Cisco Gains after Profit, Sales Tops Analysts' Estimates

Below are some financial highlights from the company's press release:

Cisco Reports 4th Quarter and Fiscal Year 2011 Results

-Cash flows from operations were $2.8 billion for the fourth quarter of fiscal 2011, compared with $3.0 billion for the third quarter of fiscal 2011, and compared with $3.2 billion for the fourth quarter of fiscal 2010. Cash flows from operations were $10.1 billion for fiscal 2011, compared with $10.2 billion for fiscal 2010.

-Cash and cash equivalents and investments were $44.6 billion at the end of fiscal 2011, compared with $43.4 billion at the end of the third quarter of fiscal 2011, and compared with $39.9 billion at the end of fiscal 2010.

-During the fourth quarter of fiscal 2011, Cisco repurchased 95 million shares of common stock under the stock repurchase program at an average price of $15.85 per share for an aggregate purchase price of $1.5 billion.

Subtract the $ 1.2 billion of capex from the $ 10.1 billion of cash flows from operations and you have a company that produced free cash flow of $ 8.9 billion in a tough transitional year.

Cisco has clearly made quite a few missteps. Yet, if you step back a bit it's a company selling at an enterprise value of $ 47.4 billion generating $ 8.9 billion of free cash flow. Not exactly expensive.

Shares Outstanding: 5.5 billion
Stock price at yesterday's close: 13.73/share
Market Cap: 5.5 billion*$13.73: $ 75.5 billion
Net Cash on the Balance Sheet*: $ 27.8 billion
Enterprise Value: $ 47.7 billion
Free Cash Flow: $ 8.9 billion

Enterprise Value/Free Cash Flow = 5.4x

Now, I happen to subtract stock based compensation when calculating the free cash flow of a company that uses lots of stock options to compensate employees.

Cisco is clearly one of those companies.

 This approach is meant to be conservative and add a margin of safety**.  Using my more conservative free cash flow numbers Cisco's enterprise value to earnings multiple is still just 6.5x.

Neither number is perfect but I think the 6.5x multiple uses cash flow that, while conservative, better approximates Cisco's economics.

"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting." - Charlie Munger

"...double-entry bookkeeping was a hell of an invention. And it's not that hard to understand. But you have to know enough about it to understand its limitations - because although accounting is the starting place, it's o­nly a crude approximation." - Charlie Munger

Munger on Accounting

Cisco's free cash flow would have to be shrinking rather quickly to justify either the 6.5x or 5.4x multiple.

I'm not a big fan of Cisco but at some point the price gets low enough that the risk/reward makes sense.

Now, if Cisco starts to grow consistently again returns for investors will likely be impressive. The good news is at the current multiple Cisco doesn't need to grow much to produce some nice longer term returns for investors.

Here's the only problem. Even if not quite as cheap, there are several fairly inexpensive large cap tech stocks (Microsoft: MSFT comes to mind as an example) with seemingly fewer difficulties than Cisco.

For investors, I would say that these are the kind of problems one wants.

Adam

Small long positions in CSCO and MSFT

* Cash and Cash Equivalents of $ 44.6 billion Minus debt of $ 16.8 billion.
** Since there's no easy perfect way to estimate what the real future cost of options to shareholders will be I go with this approach. It is admittedly a bit tough (i.e. conservative) but, not being a fan of companies that use lots of options for compensation in the first place, this is how I build in a bigger margin of safety. As an investor, I think of it as an excessive options use penalty.
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