Cisco Investors Urge CEO to Dump Consumer Unit Amid Revamp

Cisco Systems Inc. investors say Chief Executive Officer John Chambers ought to shed low-margin consumer products after his expansion into 30 new businesses slowed sales growth and distracted management.

Chambers wrote in an April 4 memo to staff that he will make several “targeted moves” in the coming weeks to restore lost credibility and sharpen the company’s focus. Getting out of the consumer division, which includes the Flip video camera, Linksys home networking, audio and media-storage products, should top his to-do list, said Sean Conner, an analyst at Nuveen Asset Management in Minneapolis.

“Cisco has realized that’s a crappy business,” said Conner, who said his firm sold its Cisco stake in January after owning shares for more than five years. “There are no synergies with the rest of their business. A lot of these businesses they put together are hurting the overall puzzle.”

Conner said he’ll consider repurchasing Cisco stock, depending on the outcome of Chambers’s moves.

Cisco’s gross margin, a measure of profitability, narrowed to 64 percent last fiscal year from 70 percent in 2003, in part a reflection of the push into consumer products. A sale or spinoff would help Chambers achieve his goal of refocusing on areas where Cisco is a leader, including the high-margin networking gear that makes up about half of its revenue.

“I look at Cisco as more an enterprise player,” said Dan Morgan, a fund manager at Synovus Securities Inc., which owned about $18 million in Cisco shares at year-end, according to Bloomberg data. “The consumer is not a natural extension.”

‘Give Up the Ghost’

Chambers should also consider retrenching from some of the other 30 new businesses Cisco has entered in recent years, said Joanna Makris, an analyst at Mizuho Securities USA Inc. in New York. These include niche products that help companies manage data centers -- areas led by Riverbed Technology Inc., F5 Networks Inc. and Aruba Networks Inc.

“Cisco has to give up the ghost at this point,” Makris said. “They’ve lost so much share and thought leadership. It’s too late to out-innovate other companies in these areas.”

Cisco’s stock has fallen 32 percent in the past year, erasing about $46.6 billion in market value. The shares declined 16 cents to $17.91 on the Nasdaq Stock Market at 4 p.m. New York time. Karen Tillman, a spokeswoman for San Jose, California-based Cisco, declined to comment.

Switching Competitors

The company faces mounting competition in switches, equipment used to direct Internet traffic, Chambers said today at a conference for investors in San Francisco. Rivals are undercutting Cisco on price, he said.

“Switching is our challenge,” said Chambers, who told the crowd that his memo earlier this week was a “call to action.” “It’s going to be a tough market for us.”

Part of the overhaul is under way. In February, Cisco named 10-year veteran Gary Moore as chief operating officer, a new position. He’s charged with making mangers more accountable, shaping the company’s strategic priorities and improving operational execution.

The move may bring more predictability to Cisco’s business, said Rob Whiteley, an analyst at Forrester Research Inc. Cisco has said it introduced products at a faster pace in the past year than in previous periods. This has made it harder to coordinate manufacturing and new software releases with the rest of the company’s schedules, Whitely said.

Victim of Success?

“Cisco has been a victim of its own success,” said Whiteley, whose firm is based in Cambridge, Massachusetts. “It created a system to spin up new products quickly. They need an executive to cut across all the projects and silos.”

Some investors lauded Chambers’s memo. Trading of bullish Cisco options that can be exercised in May surged yesterday, indicating that investors anticipate share price gains after Chambers begins acting on the plan outlined in his memo.

Cisco options traders buying new bullish contracts have pushed the ratio of puts to sell versus calls to buy, a gauge of bearishness, to 0.62-to-1, the lowest since July 2008.

Other changes may include an overhaul of Cisco’s management structure. Chambers introduced a nontraditional form of management in 2007, installing councils and committees to make decisions collaboratively. The structure was designed to encourage communication as the company expanded.

Slow Decisions

The company has become “slow to make decisions,” Chambers wrote in the memo. “We have lost the accountability that has been a hallmark of our ability to execute consistently for our shareholders.” He didn’t attribute those shortcomings to the councils and committees.

“The management matrix is very confusing,” said Kim Caughey, an analyst at Fort Pitt Capital Group Inc. in Pittsburgh, which has $1.1 billion under management and doesn’t own Cisco shares. “People need to have fewer meetings and do more work.”

Cisco’s vision has been to provide a wide range of networking products, from videoconferencing kits that consumers plug into living room TVs to the high-end switches and routers that handle network traffic.

Persuading investors to support this one-stop-shop approach has proven tough.

Erick Maronak, who oversees $2 billion in Victory Capital Management Inc.’s large cap growth fund, considered buying Cisco shares recently after owning them from 1991 to 2002. He came away from his research unconvinced that Cisco could keep up the growth, he said.

Times Have Changed

“Cisco just can’t seem to get it humming the way it used to,” said Maronak, who owns Cisco rivals F5, Riverbed and Juniper Networks Inc. “It has to do with their size, but also the products that are custom built for today’s networks are probably better at competing companies.”

Given Cisco’s record in past years of achieving revenue and profit growth, investors would be wise to give Chambers time to refine the company’s focus, said Morgan at Synovus.

“They used to just do routers and switches,” said Morgan, who has owned Cisco since the early 1990s. “That was the Cisco thing and it worked for them. Then they started getting into all this other stuff. It’s kind of confusing.”

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