Company Overview

Cisco Systems, Inc. is the worldwide leader in networking for the Internet. Cisco's Internet Protocol-based (IP) networking solutions are the foundation of the Internet and most corporate, education, and government networks around the world. Cisco provides the broadest line of solutions for transporting data, voice and video within buildings, across campuses, or around the world.

Today, the Internet and computer networking are an essential part of business, learning and personal communications and entertainment. Virtually all messages or transactions passing over the Internet are carried quickly and securely through Cisco equipment. Cisco solutions ensure that networks both public and private operate with maximum performance, security, and flexibility. In addition, Cisco solutions are found in a growing number of medium-sized commercial enterprises.

Cisco was founded in 1984 by a group of computer scientists from Stanford University. Since the company's inception, Cisco engineers have been prominent in advancing the development of IP- the basic language to communicate over the Internet and in private networks. The company's tradition of innovation continues today with Cisco creating leading products and key technologies that will make the Internet more useful and dynamic in the years ahead. These technologies include: advanced routing and switching, voice and video over IP, optical networking, wireless, storage networking, security, broadband, and content networking. (ABOUT CISCO)

In addition to technology and product leadership, Cisco is recognized as an innovator in how business is conducted. The company has been a pioneer in using the Internet to provide customer support, sell products, offer training, and manage finances. Drawing upon the company's own Internet best practices and core-value of customer focus, Cisco has established the Internet Business Solutions Group (IBSG) dedicated to helping top business leaders transform their own businesses into e-businesses.

As a company, Cisco operates on core values of customer focus and corporate citizenship. The company's philanthropic efforts are committed to helping communities prosper while also encouraging Cisco employees to learn about the needs of the communities where Cisco operates. Also, to help bolster education around the world, the company has founded Cisco Networking Academies in 128 countries dedicated to teaching students to design, build, and maintain computer networks. (ABOUT CISCO)

Cisco derives a little over half of its sales within the United States and 23% from Europe. While these sales have fuelled the company’s health, there are opportunities for growth in the company’s other geographic sales locations. China holds great potential for the networking industry as a whole because of their rapidly expanding economy and router demand from its firewall policies; Japan, on the other hand, has experienced stagnation in its economy but the overall market size is very large. For Cisco, Japan represents only 4% of revenue streams, while China provides an estimated 5%. Cisco does not enjoy such a dominant market share in these areas as it does elsewhere, and several key competitors--including Juniper in Japan--generate a larger share of business from this region. The company must also compete with entrenched regional networking companies such as Huawei. Cisco has announced that it will be doubling its spending in China, raising it to $16 billion. Cisco plans on spending that money towards adding R&D, buying more components and services in China, building training academies, and establishing a "green" technology centre. (ABOUT CISCO)

Their worldwide presence and revenue breakdown is shown in the table below.

CISCO Annual Report 2009

Cisco has one of the highest gross operating margins of its competitors because of its size and scale. The size of the company allows it to maintain a large advantage in the negotiations of its supply agreements with several of its key suppliers. Furthermore, Cisco has the lowest operating costs (as a percentage of sales) of its competitors. Cisco maintains cost levels at around 35% of total sales while other companies incur costs up to half of their total revenues (2009 ANNUAL REPORT TO SHAREHOLDERS).

Cisco still leads the market in routers, accounting for approximately 60% of sales. Cisco generates about 42% of its revenue from switches.One key advantage afforded to Cisco by its size is the ability (and willingness) to spend more on research and development than its competitors. As with most high technology industries, research and development spending can drive innovation of new products and stave off the obsolescence of older offerings.

In addition to other large networking companies with broad portfolios, Cisco also competes with niche networking companies, especially as it reaches into more specified product markets, one example would be Symantec, the leader in internet security.

Performance over the last 2-3 years

During Cisco’s 2009 fiscal year, revenue decreased 8.7% to $36.1 billion year over year. Revenue fell due to a decrease in sales in all regions except Japan and all products and services except communications. Its net income fell 23.8% to $6.1 billion from $8.1 billion in 2008 (2009 ANNUAL REPORT TO SHAREHOLDERS).Routing revenue ended the year at $6.3 billion, down 21% year-over-year. Switching revenue was $12.0 billion, a decrease of 11% over last fiscal year. Advanced Technologies revenue was down 4% year-over-year to $9.2 billion. Total service revenue was approximately $7.0 billion, growth of 8% in fiscal year 2009 (2009 ANNUAL REPORTTO SHAREHOLDERS).

Below is Cisco's revenue (millions $) vs. operating expenses followed by its four primary product sectors, with percent of total revenue for 2009.

(2009 ANNUAL REPORT TO SHAREHOLDERS)

(2009 ANNUAL REPORT TO SHAREHOLDERS)

Routers (22% of total revenue)

Cisco’s revenue from their router business in 2009 was $6.7 billion (2009 ANNUALREPORT TO SHAREHOLDERS). Routers enable the communication of data packets over the Internet. Cisco aims to improve the intelligence, security, reliability, scalability, and level of performance of information transfer with each new router it develops.

Switches (41% of total revenue)

This sector generated $12.0 billion in revenue in 2009 (CISCO 2009 10K).Cisco currently holds around a 70% market share over the $14 billion dollar Ethernet switching market(2009 ANNUAL REPORT TO SHAREHOLDERS).

Advanced Technologies (32% of total revenue)Cisco's Advanced Technologies sector represents great opportunity for incremental growth. The company is expected to expand this product sector through research and development as well as acquisitions focusing on opportunities which include

Higher networking layers More sophisticated security capabilities and More complex storage networking demands.

Other (5.6% of total revenue)

Cisco offers several services from this sector which includes both technical and more involved support. A few examples of these services include:

Advanced Services involves service and consulting for network users. Focused Technical Support aims to improve operational efficiency and shorten

problem resolution time. Network Optimization Support aims to increase the efficiency and improve the

performance of networks.

Financing Structure of Cisco

Debt to equity ratio (WIKIPEDIA, Debt to equity ratio)

The company is majorly financed through equity as shown in the below table the Debt to equity ratio year on year. The Debt to equity ratio is increasing over the year starting with 0.69 in 2007 to 0.76 in 2009 which explains that assets are primarily financed through equity.5

2009 2008 2007

Long Term Debt $10,295,000 $6,393,000 $6,408,000

Total Stockholders' Equity $38,212,000 $33,625,000 $30,918,000

Debt/Equity Ratio 0.27 0.19 0.21(CISCO BALANCESHEET FOR YEAR 2009, 2008 and 2007(yahoo finance))

Major competitor for CISCO is Hewlett-Packard Company and the financial structure is that they are increase debt year on year so there debt to equity has been increased by 1.3 in 2007 to 1.83 in year 2009. As it has got high Debt to Equity ratio implies that a company has an relatively higher commitment to pay fixed interest charges

2009 2008 2007

Long Term Debt $13,980,000 $7,676,000 $4,997,000Total Stockholders' Equity $29,960,000 $24,995,000 $21,586,000Debt/Equity Ratio 0.47 0.31 0.23

(HEWLETT-PACKARD COMPANY BALANCE SHEET 2009, 2008 and 2007 (yahoo finance), 2010)

Cisco is operating in a highly Technology drive and any new product by the competitor can decrease the revenue of CISCO which can result in decrease in profit which in turn they will be not be able to pay the interest on the debt, but with Debt to equity ratio less than 0.30 it is able to cushion it out. But it also means that the CISCO is exposing itself to a large amount of equity

Debt-Asset Ratio (INVESTOPEDIA, 2010)

The Debt to Asset Ratio measures the percentage of the company's Total Assets that are financed with debt. This ratio basically looks at what debt the company owes, and compares that debt to what assets the company owns. Cisco has fairly less percentage of it asset has been are financed more through equity rather than debt.

2009 2008 2007Long Term Debt $10,295,000 $6,393,000 $6,408,000Total Assets $68,128,000 $58,734,000 $53,340,000Debt-Asset Ratio 15% 11% 12%

(CISCO BALANCESHEET FOR YEAR 2009, 2008 and 2007(yahoo finance))

Weighted average cost of capital

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. (WIKIPEDIA, Weightedaverage cost of capital)

In order to calculate WACC we need the following information

Cost of Equity Value of Equity Cost of debt Value of Debt

Cost of Equity

Cost of equity can be calculated using different technique. CAPM is one of the technique to calculate the cost of equity and one of the method which also includes market risk Beta. The formulae is

Ke = Rf + beta x ( Rm - Rf )

Ke =Cost of equity

Rf = Risk free rate of return

Rm = Market return

Here we have considered Risk free rate of return as the return on the 30 year T- bills of US Treasuries which is 4.38% (TREASURIES, Bloomberg US, 2010)

For market return we have taken the15 year annualised return on S&P 500 index which is 10.92% (WIKIPEDIA, S&P 500 return)

Beta is 1.23 (FINANCE, Beta CISCO Yahoo)

Therefore by substituting the value we get the cost of equity as 12.43%

Value of Equity

Equity value is the value of a company available to owners or shareholders (WIKIPEDIA,Value of equity, 2010).

Value of equity can be calculate by knowing the Current share price and number of share outstanding.

No of shares Outstanding = 5710000000 (FINANCE, Share Outstanding of Cisco Yahoo)

Current share price = $22.51 (FINANCE, Share price of cisco Yahoo)

Value of Equity = No of shares Outstanding Current share price

Value of Equity will be = $128,532,100,000

Cost of debt

The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. This is one part of the company's capital structure, which also includes the cost of equity. (INVESTOPEDIA, Cost Of Debt, 2010).

The following table shows the Debt which CISCO has with the effective rates of the bonds and the Fair value of the same.

Cost of Debt Amount Effective rate5.25% fixed-rate notes, due 2011 $3,000,000,000 3.12%5.50% fixed-rate notes, due 2016 $3,000,000,000 4.34%4.95% fixed-rate notes, due 2019 $2,000,000,000 5.08%5.90% fixed-rate notes, due 2039 $2,000,000,000 6.11% Average Effective rate 4.66%Fair value of the Company’s long-term debt $10,500,000,000

(CISCO, Annual report 2009 page 59)

Cost of debt is nothing but the average of the Effective rate which is 4.66% and we know the Market value of bond as $10,500,000,000. We can now calculate the WACC.

V K VK

Equity $128,532,100,00012.43

%$15,970,563,287.

35Bond $10,500,000,000 4.66% $489,562,500.00

Total $139,032,100,000 $16,460,125,787.

35

So WACC will be

WACC = $16,460,125,787.35 $139,032,100,000

WACC = 11.84%