E-BUSINESS SPECIAL REPORT
The Cisco Effect

Once upon a time, the performance of bellwethers like Cisco (Nasdaq: CSCO) told the economic fortunes of the technology sector as a whole. But Cisco's dismal financial showings over the last two years have left some industry observers wondering whether the company still wields much influence.

Although Cisco certainly still has an influence in the tech sector, its power has lessened, Morningstar.com analyst David Kathman told the E-Commerce Times. "Its main attraction back in 1999 [and] 2000 was its status as the leading provider of Internet switching gear for phone companies and ISPs, back when the Internet was thought to have virtually unlimited potential," he said.

But that has changed. Most people are well aware that many of the growth projections once made by Cisco and others were little more than pipe dreams. As a result, "Cisco looks a lot less attractive, as its market cap indicates (down about 85 percent from its peak)," Kathman said. "I get the sense that Cisco is still the clear leader among makers of Internet switching gear; it's just that the industry has taken such a tumble."

Sector Under Par

In fact, the tech sector overall has performed well under par despite a rally that Fred Hickey, editor of the High Tech Strategist newsletter, predicts will be a short spike.

"We've had warning after warning after warning" from tech companies about the fourth quarter, he said. "Everyone is talking about a weaker IT environment into 2003."

Cisco, for its part, has tried to pull itself out of a financial mire and get its bearings in a difficult economy. The company has purchased a fair number of its own competitors, and its direction has prompted analysts to proffer some fairly upbeat forecasts.

But the market has changed so dramatically that it is difficult to grasp the meaning. "Yes, this company is worth much less than it once was. But the public market is starkly distinguishing Cisco from its competitors," Fritz Kaegi, an equity analyst in the networking and telecommunications equipment sector at Morningstar, told the E-Commerce Times. "Investors say Cisco is worth $81.1 billion, while Lucent (NYSE: LU) is worth $2.4 billion, Nortel (NYSE: NT) $3.1 billion, and JDS Uniphase $3.1 billion."

Dramatic Shift

If networking equipment companies are analyzed at a very high level, Kaegi noted, it would be hard to understand why the difference in valuation holds, "because each of the companies is ostensibly in the same broad line of business" and they all "have taken severe hits in the downturn."

It is better to take a bottom-up view, even when "firms' fortunes rise and fall together," he suggested, to get a more realistic view of a company and the marketplace.

"Product mix, the firm's particular economics, capital structure, how growth is to be financed, management, technology and service differentiation, how products are to be sold to customers -- each factor has a vital impact on a firm vis-a-vis its industry compatriots," Kaegi explained. "The choices that companies make during the ups and downs have a huge impact on their prospects and their ability to cope with change."

Proving Its Worth

According to those criteria, Cisco has proven itself worthy. "When you look at Cisco this way, the company does sparkle," Kaegi said. "It may never again be the most valuable company in America, but there's little doubt its fundamentals are among the best in the equipment industry.

"The public market, measured by total market value or price for a dollar of sales, is saying that Cisco is a much better networking company than its competitors," he noted. "It can also be an example for how valuable good stewardship can be to a tech company's survival."

Watching Cisco

While Cisco's sales serve as a pretty good indicator of what is happening to overall demand for networking equipment, "you have to be much more cautious about the conclusions you draw" about what the company's situation means for other firms in the sector, Kaegi added.

"As the leader of the industry, [Cisco] may experience less volatility in demand than smaller players would. In this way, it is a good indicator," he explained. "Yet, it would be a mistake to stop your analysis of other companies there at the industry level.

"To extend the nautical analogy of the bellwether a bit too far, some Cisco factors like capitalization and sales levels give you good insight about the direction of the tailwinds but don't tell you about whether another vessel on the same seas would be seaworthy."

The industry is watching Cisco carefully, but if the company were to show renewed signs of life, "people would take notice, but they wouldn't get as excited as they did three years ago when anything Internet-related got people's hearts racing," Kathman said.