Cisco's Consumer Focus Pays Off

The networking colossus is benefiting from the acquisition of set-top box maker Scientific Atlanta and burgeoning demand for video over the Internet

Before the dot-com bust, Cisco Systems spent tens of millions of dollars on glitzy ads aimed at raising consumer awareness of its networking equipment business and how it plans to connect Internet users with its routers and switches that send information from computer to computer.

Today, many consumers would be hard pressed to tell you exactly what Cisco makes. But if financial figures released on Feb. 6 are any indication, that may soon change.

Cisco (CSCO) has long dominated the market for routers and switches for corporations and communications providers. But more recently it has bulked up on businesses that cater to consumers, acquiring Scientific Atlanta, the nation's No. 2 cable set-top box maker, and Linksys, a maker of consumer routers.

Right Buys, Right Time

Cisco rode the tailwind of the decision to broaden its portfolio in the fiscal second quarter, saying profit for the three months ended Jan. 27 surged 40% to $1.92 billion, or 31¢ a share. That's up from $1.38 billion, or 22¢, a year earlier, as companies snapped up its Internet-related products to work, play, and communicate online.

Sales surged 27% to $8.44 billion, beating Wall Street expectations for sales of $8.28 billion, as cable, satellite, and telecom companies raced to deliver combined Internet-related products and services, large corporations upgraded networks, and consumers snapped up low-cost networking gear. "We believe the network is becoming the platform for all communications and [information technology]," Cisco Chief Executive John Chambers said in a conference call.

By all, Chambers also means video and other forms of entertainment. His company's transformation is well timed as corporations such as Amazon (AMZN), Apple (APPL), and Microsoft (MSFT) launch on-demand download services for movies and other video content and as consumer electronics makers build in network connections to flat-screen TVs, TiVos, and portable devices. The same day Cisco announced earnings, retailing giant Wal-Mart (WMT) introduced a test version of its video download service (see, 2/7/07, "Wal-Mart Enters the Movie Download Wars"). Meantime, the rise of YouTube, MySpace, and other social-networking sites is also driving a need for increased bandwidth from Internet service providers.

Boost from Set-top Boxes

While consumer businesses still generate a fraction of Cisco's sales, they're becoming increasingly important. With companies racing to beat each other to market, they are turning to Cisco as a one-stop shop for consumer equipment as well as big-ticket equipment and software to manage networks.

The company's latest results illustrate just how well the $6.9 billion acquisition of Scientific Atlanta is boosting growth in its core networking business. In the same way interest in Apple's iPod is drawing buyers to the company's computers, demand for Scientific Atlanta set-top boxes is fueling interest in Cisco's other products. Think halo effect, Cisco style.

As consumers buy high-definition televisions, they are slowly replacing their old cable boxes with digital and HD set-top boxes. Cisco last quarter sold 100,000 set-top boxes to cable operators, which in turn purchased new routers, switches, and Cisco digital compression technology to upgrade the pipe feeding such boxes, said Charles Giancarlo, Cisco's senior vice-president and chief development officer.

Integration Plans

Cisco's standalone sales during the quarter rose 18% from a year earlier, while sales of Scientific Atlanta products climbed 21%, to $639 million. "We're going to be in the sweet spot for a large part of the business," Chambers said.

The challenge for the company will be how well it tightly couples the technology from its consumer acquisitions before the equipment spending boom begins to slow. Scientific Atlanta set-top boxes, for instance, should easily pair with Linksys wireless routers and other such devices to move content around the home and onto portable equipment. "We definitely see them coming together," Giancarlo says. "[But] we're at the very beginning of a fairly long cycle, and we have time for a slow and considered integration."

The company has been relatively silent on its plans for Linksys, a brand that's becoming familiar to consumers who have a home network. Purchased in 2003, it continues to operate somewhat autonomously, though Cisco in late September introduced in Europe a broadband platform that meshes technology from Linksys and the parent company.

Chambers indicated it may be a long time before he has to worry. The company's 20 top products account for 85% of sales, he said, and 15 of those are experiencing double-digit growth.

Get Ready for Upgrades

The news could prompt a slew of analyst upgrades. After rising 60% last year, the company's shares have been little-changed this year amid concerns technology earnings are slipping. Cisco stock jumped 5% in after-hours trading to $28.70.

Citing the continued strong trends, Cisco boosted its forecast for year-over-year sales growth in the current quarter to 19% to 20% from earlier Wall Street expectations of 17%.

Scientific Atlanta's sales may rise sharply in the second half of the year as cable providers rush to meet a federal requirement that they remove built-in security decoders from their boxes. Consumers may be able to purchase replacement boxes from the likes of TiVo at Best Buy (BBY) and other retailers, but cable providers also are likely to place new set-top box orders and continue to rent equipment to customers. Cisco also could begin selling Linksys-branded set-top boxes at retail to take advantage of the new outlet if it proves popular.

That would be just one more way Cisco is gaining traction with consumers.

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