4 Risks Cisco Systems Bulls Need to Know

Cisco (NASDAQ: CSCO) is often considered a good tech play for conservative investors, since its networking hardware business has a wide moat, the stock is cheap relative to its peers, and it pays a solid dividend. However, four big risks could still cause Cisco to either stagnate or crash in the near future.

1. The rise of "white box" networks

For decades, Cisco's business depended on enterprise customers buying bundles of its networking hardware and software solutions. Many customers believed that they had to buy all their networking hardware and software from a single vendor, like Cisco, for everything to run smoothly.

But in recent years, a growing number of companies started installing generic "white box" hardware running on open source software to cut costs. Earlier this year, AT&T tested out a high-speed network running on white box hardware, including hardware from different vendors running on different chips. Facebook has also been installing white box hardware in its data centers.

The biggest threat in this market of SDN (software-defined networking) solutions is Arista Networks (NYSE: ANET), which sells cheaper multilayer network switches for white box networks. Its hardware runs on an open-source Linux-based OS, and its FlexRoute software aims to replace traditional routers with software-based solutions. Cisco is trying to slow down Arista with lawsuits, but it isn't doing much damage -- analysts still expect Arista's revenue to soar 41% this year.

2. Its ongoing market share losses

Cisco still generated almost half its revenue from sales of routers and switches last quarter. Both units posted 9% annual revenue declines, due to tough competition from challengers like Arista, Huawei, Hewlett-Packard Enterprise (NYSE: HPE), and Juniper Networks (NYSE: JNPR).

Between the first quarters of 2016 and 2017, Cisco's global share of the ethernet switching market fell from 59% to 55.1%, according to IDC. Its combined service provider (SP) and enterprise router market share fell from 48.8% to 43.9%.

During that period, Huawei's share of the switching market rose from 3.9% to 6.3%, while its share in SP and enterprise routers rose from 16.3% to 19.8%. Juniper's market share in switches rose from 3.2% to 4.3%, and its SP and enterprise router market share grew from 14.5% to 15.6%.

Meanwhile, Arista's share of the switching market rose from 3.9% to 5.1%. HPE (which reported its results with H3C a year earlier) also saw its share of switches rise sequentially from 5% to 6%. All those figures indicate that customers are shopping around for better deals and cutting Cisco out of the loop.

3. The slowing growth of its security business

Cisco's security business, which adds cybersecurity solutions to its hardware and software bundles, is traditionally one of its fastest-growing businesses. It was built atop about a dozen acquisitions since 2000, and generated $2.2 billion in revenues last year. However, the growth of that business has been slowing down in recent quarters:

That slowdown is likely associated with its loss of market shares in networking hardware. As Cisco's ability to bundle hardware and software together weakens, higher-growth businesses like security software could suffer.

4. Stalled changes to corporate tax rates

The bulls often note that Cisco finished last quarter with $70.5 billion in cash and equivalents, so it could buy more companies to boost its top line growth again. Unfortunately, just $3 billion of that total is actually in the U.S. -- Cisco keeps the rest overseas to avoid getting hit by the U.S. corporate tax rate of 35%.

Many Cisco bulls believe that the Trump Administration and the Republican-controlled Congress will lower that tax rate and enable companies to repatriate their overseas cash. If that happens, Cisco could spend that cash on domestic acquisitions, buybacks, and dividends -- which could lift the stock. But if those proposed tax changes stall out -- as have many of President Trump's other proposals -- Cisco's business could stagnate.

The key takeaways

I personally own Cisco shares, and I remain fairly confident in its long-term growth. But if Cisco fails to counter these aforementioned risks, I might reevaluate my original thesis and consider investing in other "mature tech" plays instead.

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Leo Sun owns shares of AT&T; and Cisco Systems. The Motley Fool owns shares of and recommends Arista Networks and Facebook. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.