Growth-hungry Cisco Systems (CSCO) has its groove back in cybersecurity — maybe in just the nick of time.
With its core network business shrinking, cybersecurity seems a good bet for Cisco, analysts say. Hacker attacks are more sophisticated and widespread, while large companies and government agencies are making digital asset security a priority.
And with Cisco being the Dow component and networking giant that it is, it can grow via acquisitions — something it's never been shy about doing. The new head of Cisco's security business, David Ulevitch, came from startup OpenDNS. Cisco acquired the specialist in advanced threat detection in 2015 for $652 million.
"I think of us as a very large security startup," Ulevitch told Investor's Business Daily in an interview. "There are only two competitors near our size, IBM (IBM) and Symantec (SYMC). We get to leverage the Cisco customer base and sales organization. But I like to operate like a startup that's growing out into the market for the first time, with products that are extraordinarily competitive, because customers are looking for best in class."
Cisco's security revenue jumped 14% to $528 million in the January quarter, growing at roughly twice the rate of the overall market. For the computer networking giant as a whole, however, fiscal 2017 revenue is forecast to grow a paltry 1% to $48.4 billion. That figure excludes divestitures.
Meanwhile, cybersecurity has room to grow, comprising only 6% of Cisco's total revenue now. Cybersecurity is one key to Cisco's shift to a software and services business model from its origins in internet routers and switches. With security and other initiatives, Cisco's goal is to grow recurring revenue from software subscriptions.
Combining Operations
In late 2016, Cisco combined its networking hardware and security businesses under David Goeckeler, a senior vice president and general manager. Cisco plans to leverage its huge networking customer base and distribution channels to sell security products.
Cisco was an early leader in internet firewalls that block unauthorized traffic from entering private networks. But Cisco, along with Juniper Networks (JNPR), let its product offerings grow stale.
That opened the door for Palo Alto Networks (PANW), Fortinet (FTNT) and others that introduced next-generation firewalls better suited for handling web-based applications a decade ago.
Cisco took its eye off the security market for a while but has "woken up," said Jonathan Ho, a William Blair analyst who follows rivals such as Palo Alto and Check Point Software Technologies (CHKP).
There is one caveat, though. Corporate budgets have tightened up since 2015's spending frenzy.
"Security is a dynamic market where you cannot rest on your laurels," Ho said. "Their customers want to stick with them, but they weren't offering compelling products before and now they seem to be doing a much better job."
Growth By Pocketbook
Acquisitions have jelled. The 2013 purchase of Sourcefire for $2.7 billion continues to breath new life into Cisco's network security products, making Cisco a player in next-generation firewalls. Martin Roesch, Sourcefire's founder, is still at Cisco as a vice president and chief architect for the security business group.
"(Cisco) has acquired a number of private companies that help them offer a broader solution than the competition," Ho added. "Customers want to buy more capabilities from a single vendor, particularly if they can integrate those solutions. That seems to be the direction Cisco is heading. And the companies they are buying are addressing more forward-looking issues like public cloud and advanced threats."
Some analysts view Cisco as a security industry consolidator that could snap up more public companies, such as Sourcefire. Acquiring Check Point or Palo Alto, for example, would double the size of Cisco's security business. But, there might be too much product overlap and integration risks, analysts say.
Instead, Cisco may kick the tires at more private companies. Aside from OpenDNS, Cisco bought Lancope for $452 million in 2015 and CloudLock for $293 million last year.
Cisco's investment fund has backed many security startups, including Exabeam, HyTrust, Netronome, Team8, eSentire, and Skyport Systems. As in the case of OpenDNS, Cisco sometimes acquires startups it has backed.
VC Funding Jumps
Venture capital funding in cybersecurity jumped in 2014 and 2015 after a slew of high-profile data breaches, reaching $2.5 billion in 2014 and $3.7 billion in 2015, says CB Insights.
Ulevitch says he expects a shakeout among startups. It could give Cisco an opportunity to acquire emerging security technologies at fire-sale prices.
"I think we're in for a Malthusian (unsustainable) environment where all these startups have been funded but there's not enough customer dollars to satisfy them," he said. "There's innovation from startups but not revenue acceleration. It'll be interesting over the next 12 to 18 months. I think you're going to see a lot of consolidation."
UBS estimates that Cisco still garners half of security revenue from firewalls and intrusion prevention appliances, though it's expanding into other security markets.
By acquiring Sourcefire in 2013, Cisco obtained firewall, intrusion detection and advanced malware protection technologies.
With the purchase of ThreatGrid in 2014, Cisco got "sandboxing" technology that executes suspicious code in an isolated environment to test if a program contains a virus or malware. Through those moves, analysts say Cisco has been gaining share vs. FireEye (FEYE) in the advanced malware protection market.
Proofpoint Rivalry
Cisco also competes with Proofpoint, an email security specialist. Proofpoint's software spots malware-ridden emails before they arrive in inboxes. Cisco gained email protection tools through the 2007 acquisition of IronPort Systems.
With corporate America outsourcing more information-technology department workloads to cloud service providers, such as Amazon Web Services, many security firms have been racing to acquire cloud tools. With the CloudLock acquisition, Cisco gained cloud-access security broker software. Cloud-access security products act as a middleman between a corporate network and web applications hosted externally.
Analysts say internet firewalls have become a security hub, meshing various technologies. But, one worry for Cisco is that spending on network security could slow as companies prioritize new security tools.
UBS analyst Steven Milunovich, in an October report, said Cisco could push into identity and access management, where many private companies are active, as well as security vulnerability management. Okta (OKTA), a startup that provides access management tools that authenticate network user credentials, has filed to go public. If Cisco moves into security analytical tools, it would take on Splunk (SPLK) and others.
One of Cisco's challenges, analysts say, is in winning back "thought leadership" in how companies should combat hackers, some of whom are state-sponsored. With its networking products installed at millions of locations, one of Cisco's strengths is visibility into global internet traffic on a daily basis.
Converting Switches
To set its security technology apart, Cisco aims to turn its switches and routers into network sensors that gather intelligence and detect threats.
"We gave petabytes of data that we analyze on a daily basis, and turn into strategic effectiveness," Ulevitch said. He says Cisco has 300 security researchers, some working on artificial intelligence and machine learning.
Vijay Bhagavath, an analyst at Deutsche Bank, says Cisco outlined plans at a security conference in March on using its "Talos" security research outfit for tracking threats across corporate networks. Cisco expects attacks that flood a website with illegitimate requests for data to increase, for example.
"Cisco's moat in next-generation security is driven by scale of the company's 400,000-plus sales-channel footprint and $200 billion networking installed base," Bhagavath said in a report.
Amid slowing revenue growth, Cisco has restructured to lower costs. In 2016, Cisco cut 5,500 positions, about 7% of its workforce.
While Cisco transforms itself, it has steadily hiked dividends. Cisco stock has been trading at the highest levels since the eve of the 2008 bear market. Cisco has $70 billion in cash on its balance sheet, giving it dry powder for shareholder returns and strategic moves.
After shooting past the 32 level in mid-February, Cisco shares climbed then retreated. The stock was up 0.2% Monday to 33.02.
