Cisco Systems (CSCO 0.27%) posted better-than-expected fiscal third-quarter results. Yet because of management's disappointing outlook for the current quarter, the stock dropped during after-hours. So should investors stay away from the legacy tech giant, or should they buy the dip and hope for a brighter future beyond the short-term uncertainties?
Unexciting short-term results
Amidst its multiyear transition from its legacy on-premises hardware networking business to a subscription-based software portfolio, Cisco posted results above guidance during its fiscal third quarter, which ended May 1.
Thanks to the strong demand across its broad portfolio, revenue increased 7% year over year to $12.8 billion. Even if you exclude the extra revenue contribution from acquisitions during that quarter, revenue growth would have reached approximately 6.1%, above management's growth guidance of 3.5% to 5.5%.
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In particular, and consistent with the previous quarters, the company's cybersecurity segment delivered strong top-line performance, up 13% year over year to $875 million, partly thanks to its cloud platform Umbrella and identity solution Duo Identity.
Also, Cisco reaffirmed its recent recovery with its webscale cloud business. During the previous years, Cisco failed to propose flexible and cost-effective networking solutions for cloud giants, which resulted in market share loss in the attractive high-speed data center switching market against the innovative cloud networking vendor Arista Networks. But these challenges seem to be over. During the earnings call, CEO Chuck Robbins indicated Cisco's webscale business grew 25% year over year on a tough comparison from the prior-year quarter's 70% growth.
However, these better-than-expected fiscal third-quarter results remain unexciting. Revenue had declined 7.5% year over year during the prior-year quarter, which provided an easy top-line comparison.
Looking forward, management anticipates revenue to increase by 6% to 8% year over year during the current quarter, as customers are looking to update their networking infrastructures to allow their employees to securely work from anywhere.
But because of supply chain constraints across the industry, non-GAAP (adjusted) gross margin should drop to a range of 63% to 64%, down by 150 basis points at the midpoint compared to the year before, which disappointed investors.
Cisco's transition is materializing
So because of Cisco's uninspiring top-line performance and short-term outlook, the stock is trading at a modest forward enterprise value-to-sales and price-to-earnings ratios of 4.2 and 15.1, respectively. That indicates the market doesn't expect any significant improvement in the company's results going forward.
Yet Cisco seems positioned to succeed in the transformation of its legacy hardware portfolio to a subscription-based software business.
During the last quarter, revenue from software reached $3.8 billion, up 13% year over year. And 81% of that software was sold as a subscription, up from 76% in the previous quarter. I expect this transition to intensify over the next several quarters, as Cisco revealed in March its new as-a-service offering, Cisco Plus, to allow customers to purchase its hardware, software, and services under simplified and unified subscriptions.
Besides, in addition to its internal developments, the company is poised to capture growth opportunities in its core networking and security businesses with acquisitions it can leverage thanks to its large sales and marketing footprint. As an illustration, following three completed acquisitions during the last quarter, the company announced this month its intention to acquire Kenna Security to beef up its cybersecurity offering with vulnerability management capabilities.
Cisco's rock-solid balance sheet, with $12.0 billion of cash, cash equivalents, and investments in excess of total debt at the end of the last quarter, should support similar acquisitions going forward.
Thus, despite unexciting short-term results, investors should consider buying Cisco stock to take advantage of the company's modest valuation in regards to its encouraging transition away from its legacy portfolio and business model.
