CSCO Earnings Preview and Restructuring. Putting Lipstick on Pig

by Dan May 6, 2011 8:18 am • Commentary

Yesterday CSCO announced a well telegraphed and a well needed plan to restructure the company in effort to better “streamline operations”… or whatever.  It’s all a bunch of mumbo jumbo in my opinion, and any organizational changes will take quarters to really affect the bottom line, unless they announce some mass layoffs,  and soon.

-The news of restructuring doesn’t change the fact that the company’s core router and switching business that represents about 1/2 their sales and almost three quarters of their operating income is facing massive pricing pressures and market share declines.  So any effort by the company to maintain market share comes at the cost of gross margins and thus earnings……..they are in a battle to avoid the likely result of finding their core business in commoditized hell while desperately searching for growth.

-The analyst community generally took the news as neutral to positive but most agree that it is necessary for a new operational plan and now view as a show me story.  Street is fairly mixed on the name with 23 buys, 22 holds and 2 sells.

EVENT: FY Q3’11 earnings report May 11th (after the close)

-the options market is currently implying about a 6% move vs the 8 qtr avg move of ~6.5% and the average over the last 4 qtrs of ~11%.


After reading through the company’s press release regarding the restructuring, and Wall Street’s read through I see little to get excited about in the near term.

-While expectations are very low heading into the April qtr, many see the July qtr consensus estimates as overly optimistic and likely to cause the company to again lower the out qtr guidance.

-Big question in my mind is whether or not management will just “kitchen sink” the balance of the year and possibly take down longer term growth targets in an effort to establish a series of beats to co-inside with their expected restructuring milestones in the quarters to come???  If they do this you could see one more flush lower to the ~$14-15.00 area which marks the lows from early 2009 and levels not see before that since 2002.

-I think it is a hard short to press at this time especially when you consider managements new found focus on righting the ship……The risk reward at these levels is probably down $2.5 to up $5-7 if business environment turns around along side operating improvements.


1st you could simply buy the stock as I think the near-term downside is about $14 -15 (down about 15-18% 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.   Read post from April 6, “CSCO, Lost and then found?  Ways To Play A Potential Rebound…”
1st TRADE: CSCO (ref 17.48) BUY Call Spread Risk Reversal in Jan12
-Sell the Jan12 15 Put at ~.70 and Buy Jan12 19 / 22.50 call spread for .70
-Sell Jan12 15 put at ~.70
-Buy Jan12 19 call for ~1.00
-Sell Jan12 22.50 Call at .30
Break-Even on Jan12 Expiration:
Upside: stock btwn 19 (up 8.5%) and 22.50 (~28%) can make up to 3.00 (or about 17% of the underlying).
Downside: stock btwn 19 and 15 NO LOSES, other than mark to market as the Put you are short will gain value as it gets closer to the strike…..WORST CASE stock $15 or below (down ~14%) 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 .22. 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 yesterday’s restructuring and July guidance stays put, then look to short dated tight call spreads, DEFINE YOUR RISK WITH LITTLE PREMIUM OUTLAY.
TRADE: CSCO (ref 17.48) BUY MAY 18 / 19 Call Spread for ~.22
-Buy May 18 call for .34
-Sell May 19 call at .12
Break-Even on May Expiration
Upside; stock btwn 18.22 (up ~4%) and 19 (up ~8.5%) you can make up to .78, above 19 you make all .78.
Downside:stock btwn 18.22 and 18 you lose .22 premium you paid, and below 18 you lose all .22.

As we noted last Friday in a post titled ” CSCO Catch Up Play: Potentially Add 6.5% Yield By June Expiration For Next To Nothing” there are ways to add yield to an existing long with out adding risk, See below:


-Long CSCO at 17.48

-Buy 1 June 19 call for .24 and

-Sell 2 of the June 20 calls for a total of .22 (.11 each)

(In this example the CSCO JUN 1×2 Call Spread costs you .02)

Break-Evens on June Expiration:

Downside: If the stock is below 17.48 you suffer loses as you would if you were just long the stock, plus the loss of the .02 in premium that you paid for the call spread.

Upside:-Between 17.50 and 20 you make the gains of your long stock

Between 19 and 20 you can make up to .98 plus the gains in your stock.

-Best case scenario the stock closes at 20 (up ~14% ) and you would make 2.52 in your stock and .98 in the call spread (or nearly an extra 5.5% yield from the options overlay).

-Stock above 20 on June expiration your long stock is called away up 14% and your call spread expires worth .98, so you have effectively made ~20%.

TRADE RATIONALE: If you are long and not going to sell, but think the stock could have a relief rally if the company was able to beat earnings estimates and maintain or even raise next quarter guidance, it may make sense to consider a strategy like this to help add some yield to your long, with only adding a small premium outlay, which happens to be the only added risk.

There is always the risk that the stock rips and you have essentially given it away at 20. But you would be selling your long at 20.98 (up ~21%) on June expiration (consider that you are long at 17.48 and you wrote one June 20 call against your long position and then you own a June 19/20 call spread that you can make maximum of .98. So effectively you have made 2.52 on your overwrite that is called away and then .98 on your call spread.)

In my opinion, the likelihood of a rally much above 20.98 by June expiration is not great