Cisco's upside potential

When the economy finally gets back on track, the networking giant will play a key role in some of tech's biggest trends.

By Michael V. Copeland, senior writer

NEW YORK (Fortune) -- There have been a string of tech companies signaling that for their business at least, the worst may be over.

Starting earlier this week with Intel (INTC, Fortune 500), and followed by IBM (IBM, Fortune 500) and Google (GOOG, Fortune 500), these tech heavyweights unveiled both earnings and outlooks that indicate, if not exactly good times ahead, nothing worse.

Revenue at all these companies is poised to surge when the economy rebounds. Intel will sell more chips, IBM more software, hardware and services and Google more ads. One company that is also primed for a big boost from any recovery is Cisco (CSCO, Fortune 500).

The only real news out of Cisco in the past few days is that it has continued trimming its workforce to reach a stated goal of around 2,000 fewer employees worldwide. Cisco employs more than 66,000, so the cuts are very small as a percentage.

According to CEO John Chambers, anything less than a 10% cut doesn't count in his book as a mass layoff. In his parlance it's more of a restructuring. "This limited restructuring is part of our ongoing, targeted realignment of resources and was previously discussed on our fiscal second and third quarter 2009 earnings calls," reads a statement issued by Cisco.

Given the telegraphing of the layoffs it's not surprising that Wall Street shrugged them off, and preferred to focus on a "buy" rating from Citi's Richard Gardner who initiated coverage on the networking giant. Gardner's rating and his price target of $23 have helped push shares of Cisco back to where they traded last October, before hitting a long downward trend that bottomed in March at $13.61.

Since its low more than four months ago, Cisco stock has marched up 42%, more or less with the Nasdaq which has soared 46% during the same period. Still that is far less than many of its large-cap technology peers that have seen shares up north of 50% since March lows. While not exactly cheap, a 12-month forward P/E of about 16 is below many of its tech peers.

Why Gardner believes there is more headroom for Cisco stock, and why it is worth taking a look at, is the key role it will play in some of technology's biggest trends: the continued growth of the Internet and spread of Internet Protocol or IP standards, and the related trend of cloud computing.

These massive technological shifts, while slowed at the moment by tight budgets and uncertain financial futures, are happening. What they require are faster networks, which of course, is what Cisco's gear is all about.

"Long-term we view Cisco as a key beneficiary of rapid growth in Internet traffic," Gardner writes in a note to clients. "While one might intuitively expect this growth to slow, we expect traffic growth to remain in the 30% to 50% range during the coming decade due to rapid growth in video traffic. Cisco should also benefit from the migration to IP technologies in areas that have historically been dominated by other technologies (mobile backhaul is one example)."

It's hard to argue with that long-term view. When spending by Cisco's customers really returns is the big question. If the economy dips again, so does Cisco's business. But if the economy starts to improve toward the end of this year, and into 2010, the San Jose-based company could be off to the races. Investing now would be placing a bet on the start of a real recovery toward the end of this year.

John Chambers will have his chance to offer his own views on the future when Cisco reports fiscal fourth-quarter results on August 5th. To top of page

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