CSCO, Lost and then found? Ways To Play A Potential Rebound…

by Dan April 6, 2011 8:19 am • Commentary

On Monday CSCO CEO John Chambers issued a memo to all email (excerpts are below) identifying the companies many strengths, while also their loss of focus and in some cases neglect.  Chambers, in my opinion, is a truly unique CEO in a time when most are empty suits. The Buck Stops With Him.  I respect that, even if he has presided over a colossal mismanagement  of a once great technology innovator / competitor.  Make no mistake, this is not DELL, HPQ or MOT.  If there was ever a CEO with the ability to turn around his company’s priorities and get things going in the right direction, it is Chambers. Read the whole thing in the Wall Street Journal (use this link, then click top search result if you don’t subscribe to the WSJ)

Excerpts from Memo:

From: John Chambers

Sent: Monday, April 04, 2011 2:19 PM

Subject: Message from John: Where Cisco is Taking the Network

“I’d like to share with you my thoughts about Cisco,

our strategy is sound. It is aspects of our operational execution that are not. We have been slow to make decisions, we have had surprises where we should not, and we have lost the accountability that has been a hallmark of our ability to execute consistently for our customers and our shareholders. That is unacceptable. And it is exactly what we will attack.

That said, today we face a simple truth: we have disappointed our investors and we have confused our employees. Bottom line, we have lost some of the credibility that is foundational to Cisco’s success – and we must earn it back. Our market is in transition, and our company is in transition. And the time is right to define this transition for ourselves and our industry. I understand this. It’s time for focus.

We now need to prepare ourselves for what’s next, as you will see Cisco make a number of targeted moves in the coming weeks and as we move into FY12. These actions will be based on uncompromising integrity and will represent a very simple set of guiding principles:

1. We will not fix what’s not broken. There are numerous areas where we’re executing incredibly well for our customers and partners. Our five company priorities are established: leadership in core routing, switching and services; collaboration; data center virtualization and cloud; architectures; and video. The importance of delivery to market through our partners is also clear – and we will do nothing but reinforce this.

2. We will take bold steps and we will make tough decisions. With change comes disruption, and you will see this necessary and healthy disruption as we make meaningful decisions in a timely, targeted and measureable [sic] way. We will address with surgical precision what we need to fix in our portfolio and what we need to better enable.

3. We will accelerate our leadership across our five priorities and compete to win in the core.

4. We will make it easier for you to work at Cisco, as we make it easier for our customers and partners to work with Cisco. We will significantly rework our systems, tools and funding models to do this. We will reshape the operational foundation in order to empower our teams, integrate our major functions, and allow our people to focus on inspiring and important work

We are all responsible for driving operational excellence across Cisco. As you’d expect, I’m asking each of you to play your part in this transition. The responsibility does not fall on one leader or one team. As I’ve said before, we will look back at this time in Cisco’s history and remember it as challenging, and important to the future of our company. Plain and simple – we need to roll up our sleeves and work it out, together. I’m ready, your leadership team is ready, and I know you are ready.

I want to leave you with a question: what do you want Cisco to be? I want it to be a company that keeps changing the way the world lives, works, plays and learns. A company that knows how to win and intends to continue that track record. A company that’s taking the network where it needs to be, with focus. And at a place that puts people, customers and communities at the core of its values. That’s Cisco, no excuses.

Ok, the guy seems pretty fired up. But how do you just “come about” on a $40bln company?  Well Chambers has a Gazillion reasons (his holdings in the stock) and ultimately his legacy to get this figured out.


1st chart below shows the massive under-performance of CSCO vs the Nasdaq 100 in the last 4 months as result of a series of missed earnings and lower guidance.

CSCO (white) vs the Nasdaq 100 (orange) 1 yr chart by Bloomberg

2nd chart shows the 3 consecutive gaps after the last 3 earnings announcements.  This is not a very constructive pattern and the the 3rd chart shows the almost completion of this corrective phase.

1 yr CSCO chart by Bloomberg
3 YR CSCO chart by Bloomberg
Valuation /Sentiment/ Growth (or lack thereof):
-company is not growing earnings, at least not expected to in FY 2011, while sales are expected to grow in the high single digits, which excluding 2009 in the height of the recession, this is expected to be the slowest pace for revenue growth since 2003.
-stock trading at about 12x its FY 2011 gap EPS estimate which is at the low end of its 10 year valuation range.
-Street currently has 27 buys, 19, holds and 2 sells with an avg 12 month price target of 23.51.
-As for large holders, in the last round of 13f filings reported for q4 2010, 21 out of 30 of the top holders have reduced their stakes, some significantly.  Now this sort of wholesale selling is a large part of the stocks under-performance, and the trick to making money long again will be anticipating when the dumb mutual fund money has to pile back in.
-Chambers has its work cut out for him, and this is not the first time he has tried to right the ship….Truthfully to make money in the stock on the long side they don’t need to really fix any of the problems, they just need to make the appearance that they are for the stock to start rallying again.
-The fact that Chambers did not make himself available to the press leads me to believe they will be giving more details on their call following earnings on May 11th or they will set a separate date to have an analyst meeting either in late spring or probably early fall.  Last year their analyst meeting was Sept 14, read here.
-while i clearly see the potential for further downside in a weak overall market or continued poor company performance, I like the risk reward near these levels, there is a lot of bad news in the stock and a decently articulated plan in the near term could have the stock back towards 19, while some well thought out strategic moves could have the stock at back above 20 by year end.
WAYS to PLAY from the Long Side:
1st you could simply buy the stock as I think the near-term downside is too about $14 -15 (down about 14-18% from current levels).  I want to look to structures that will replicate long exposure by either defining risk or create some bands in which you get long.  I want to look out to Jan12 expiration as this turnaround is likely to take some time but also look shorter dated around a potential catalyst.
(To Read more sign up for a Risk Reversal Premium Membership)
1st TRADE: CSCO (ref 17.22) BUY Call Spread Risk Reversal in Jan12
-Sell the Jan12 15 Put at ~.80 and Buy Jan12 17.50 / 21 call spread for 1.05
-Sell Jan12 15 put at ~.80
-Buy Jan12 17.50 call for ~1.50
-Sell Jan12 21 Call at .45
Break-Even on Jan12 Expiration:
Upside: stock btwn 17.75 (up 3%) and 21 (~22%) can make up to 3.25 (or about 19% of the underlying).
Downside: stock btwn 17.75 and 17.50 lose up to .25 premium, stock btwn 17.50 and 15 lose all of .25 premium. WORST CASE stock $15 or below (down ~13%) and you are Put the stock.
TRADE RATIONALE: I want to create a structure where I start participating in the upside fairly soon but also widen the band in which i get long on the downside.  This trade will take some margin as you will be naked short the downside put.  Also this trade will have gains or loses as the stock moves closer too and further away from the Put that you are short and the Call that you are long.
2nd TRADE: BUY MAY 18 / 19 Call Spread for .25. This one I have less conviction and is clearly more Speculative, but if you are inclined to think that any news will be good news regarding restructuring when company reports May 11, then look to short dated tight call spreads, DEFINE YOUR RISK WITH LITTLE PREMIUM OUTLAY.
TRADE: CSCO (ref 17.22) BUY MAY 18 / 19 Call Spread for ~.25
-Buy May 18 call for .42
-Sell May 19 call at .17
Break-Even on May Expiration
Upside; stock btwn 18.25 (up ~6%) and 19 (up ~10%) you can make up to .75, above 19 you make all .75.
Downside: stock btwn 18.25 and 18 you lose .25 premium you paid, and below 18 you lose all .25.