Cisco, IBM, and Verizon All Have the Same Problem
Many retirees are attracted to large-cap dividend stocks for their hefty yields, and because their size and name recognition give many an impression of safety.
If only investing were so easy. Last week, Cisco (NASDAQ: CSCO) shed almost 8% after earnings, joining IBM (NYSE: IBM) and Verizon (NYSE: VZ) as significant laggards in an otherwise strong earnings season.
These companies have the same basic problem: They have traditionally been able to charge exceptionally high prices for their products and services, but customers are becoming savvier, especially in tech, and smaller competitors are offering solutions rivaling the quality of "price leaders" -- at much-lower price points.
In response, all three companies are investing in next-generation technologies and acquiring smaller businesses to reposition themselves for the future. Let's examine each in greater detail.
Source image: Getty Images.
Cisco
Cisco has long dominated enterprise hardware. While the company has acquired its way into greater diversification, it still makes 45% of its revenue from its core switching and routing hardware.
These segments are currently under attack due to the rise of software-defined networking. Rival vendor Arista Networkshas come out with its own switches geared for the data center. Its powerful EOS softwareallows the company to use the latest, most cost-effective hardware components to run its switches. In contrast, Cisco has long used custom chips developed in-house to run its switches, which is more expensive. Cisco has even reportedly contemplated selling its switching software separately in order to compete on "whitebox" solutions, as its data center segment fell 5% last quarter.
Cisco also faces pressure on its wireless segment, which contributed 5% of revenue in 2016. Low-cost vendor Ubiquiti Networksis rolling out its Unifi Elite service this quarter, aiming to poach Cisco's enterprise-class clients with lower-cost offerings. Any loss of share there could also put pressure on Cisco's enterprise switching as well.
While Cisco is touting growth in software, security, and services, its forecast of 4%-6% revenue declines reveals increased pressure in its core.
IBM
IBM has long talked up its ability to run mission-critical functions for the largest organizations. The company makes mainframes, where sensitive company data and records are stored, and its consulting wing was the go-to for any advanced IT project.
The rise of cloud computing and software-defined systems, however, posed a threat to IBM's core mainframe, consulting, and integration businesses. A turning point came in 2014, when IBM lost a huge contract with the Central Intelligence Agency, which switched to Amazon'scloud services in order to foster open collaboration between agencies and save money at the same time. The contract proved ultra-high-security entities could move to the cloud and away from locked-in data centers run by companies like IBM.
IBM countered the loss with the acquisition of cloud-storage provider SoftLayer, and has been vigorously attempting to become a force in cloud ever since.
In the most recent quarter, IBM marked impressive cloud growth of 35% year over year. The problem is, total revenue from its technology services and cloud platforms segment declined 2% and gross profit margin declined 200 basis points. That means either IBM is merely converting existing on-premise customers to its cloud, or it's losing more legacy customers than it's gaining new ones.
IBM has spent years developing Watson, its cognitive artificial intelligence product, and its cognitive computing software segment grew 5% in the first quarter. Still, that only made up roughly 20% of revenues. With most other segments declining, the company will have to grow its new initiatives faster than it currently is able to.
Verizon
Verizon is slightly different from Cisco or IBM, but has long benefited from the same advantage -- having the highest-quality, most advanced solution, which allowed the company to price its offerings expensively.
The problem for Verizon is that lower-cost wireless companies T-Mobile (NASDAQ: TMUS) and Sprinthave networks that are getting closer to Verizon's. Sprint is running ads with Verizon's old pitchman, taunting that its network quality was within 1% of Verizon's.
Meanwhile, T-Mobile has been acquiring spectrum while forcing Verizon to go with an unlimited data plan, which has apparently also slowed down Verizon's leading network.
In response, Verizon is acquiring digital-media businesses such as AOL and Yahoo!, telematics businesses like Fleetmatics, and next-generation 5G infrastructure with XO Communications for fiber, and Straight Path Communicationsfor millimeter-wave spectrum.
However, the segment, which includes digital media and telematics, generated only 5% total revenue last quarter. Meanwhile, the wireless segment, which makes up over half of Verizon's revenue, declined 5.2%.
Takeaway
Investors in these companies likely own them for safety and yield, but none are buy-and-forget companies right now. It's possible today's growth seeds will become big moneymakers in the future, but investors won't know that for years. Meanwhile, it's possible these companies are facing a long, secular decline. Investors should be aware of both possibilities and tread carefully.
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Billy Duberstein owns shares of Amazon, IBM, and Ubiquiti Networks. The Motley Fool owns shares of and recommends Amazon, Arista Networks, Ubiquiti Networks, and Verizon Communications. The Motley Fool recommends Cisco Systems, T-Mobile US, and Yahoo. The Motley Fool has a disclosure policy.