Is Slower Government Spending to Blame?

By Reuters

(Reuters) - Cisco Systems Inc's (NASDAQ:CSCO) reliance on government spending for a big piece of its business was seen as a good thing -- until governments stopped spending.

Now, a sudden crunch in spending by debt-burdened European nations and U.S. state and local governments is partly to blame for a bleak forecast that rocked global markets.

That spending slowdown has come as Cisco has expanded beyond its traditional network equipment business into everything from video cameras to computer servers, and raises concerns that the company is neglecting its main business.

The results speak more to problems at Cisco than the entire technology industry, some analysts said.

"It does seem somewhat Cisco specific," said Morgan Stanley analyst Ehud Gelblum.

"We believe the order shortfall could be more than the 'air pocket' described by (CEO John) Chambers, and instead could be the first signal that Cisco is losing share in some of its core markets as its focus on growth has diverted attention from its core businesses."

Cisco shares fell 15 percent to $20.90 in morning trading on Thursday after the company's weak sales forecast announced a day earlier.

Investors and analysts said the slowdown was puzzling because other tech companies' forecasts pointed to a recovery.

Cisco is the world's top manufacturer of routers and switches that direct Internet traffic. Customers include a range of corporations including most major global phone and cable companies and a variety of government agencies.

To preserve double-digit revenue growth, Cisco has ventured into new areas, developing videoconferencing products and buying consumer products companies, including the maker of the Flip video camera.

Chambers said orders in the fiscal first quarter ended October 30 were below initial, internal estimates by over $500 million. As a result, he forecast revenue to grow just 3 to 5 percent in the second quarter, short of Wall Street's expectations for 13 percent growth.

That was a big disappointment for a company known for solid management, and seen as a top beneficiary of the surge in global wireless and Internet traffic. Options volume on Cisco soared on Thursday, and was four times the usual volume as of mid-morning.

It was also the second quarter in a row that Cisco gave a weaker-than-expected outlook.

A disappointing sales forecast and Chambers' warning of "unusual uncertainty" among customers sparked a selloff last quarter, and some analysts said the consecutive quarters of letdowns may mean Cisco is overextending itself.

Some analysts said Cisco's high exposure to the public sector may be working against it. U.S. state and local governments have been cutting spending as tax receipts dry up.

Shares in network equipment rival Juniper Networks (NYSE:JNPR) and International Business Machines Corp (NYSE:IBM), another company with high exposure to government spending, fell 1 percent. Dell Inc (NASDAQ:DELL) shares fell 5 percent.

"I think it's more of a Cisco problem. However I think that their commentary on the state of IT is always important, so you still have to doublecheck your tech holdings in light of what Cisco says," said Fort Pitt Capital Group senior analyst Kim Caughey Forrest. She owns Cisco shares, but said she was not buying more.

Cisco is considered one of the technology sector's bellwethers because of its broad, global operations, and technology stocks often react to the company's financial updates and comments by Chambers.

Since its fiscal first quarter runs through late October, later than many peers, its outlook and comments on recent orders are seen as a more up-to-date indicator of industry trends.

"The interpretation is that if Cisco missed, they may be the bellwether that suggests a trend that may extend into the rest of the quarter," said Keith Wirtz, president and chief investment officer with Fifth Third Asset Management, which holds Cisco shares as part of its $18 billion portfolio.

He said he might buy more stock later this month if the price falls more. Investors had rushed to take profits after a two-month runup in Cisco shares, he said.

"Professional managers are susceptible to any excuse to sell," he said. "I think people are looking for a reason to harvest some of the profits right now."

(Reporting by Ritsuko Ando, Additional reporting by Jim Finkle. Editing by Kenneth Li and Robert MacMillan)

This article was originally published on 2010-11-11