Bank of America Corp (NYSE:BAC) expects public cloud migration to present a net headwind to Cisco Systems, Inc. (NASDAQ:CSCO) in the long run, as its large enterprise, commercial, and public services segments move to more efficient cloud architectures, and an increasing number of very large cloud providers move to open-source and generic networking solutions. Cisco’s transition to new growth areas (networking software, IoE, and services) and the migration of certain business lines to a cloud-based, recurring revenue model (security, collaboration and wireless) could offset part of this underlying market transition, yet it may take time to materialize, driving limited overall growth in the medium-term.
Cisco has a weak presence in hyperscale cloud environments, and parts of its customer base are transitioning to public cloud infrastructure. Longer-term, BAC sees a path towards growth re-acceleration with Cisco expanding its switching TAM by developing new Software-Defined Networking and data center orchestration tools, markets that could reach $13bn. In addition to product innovation, the company has made several acquisitions to capitalize on future growth markets. Cisco acquired Jasper Technologies, an IoE platform that helps connect the growing number of traditionally non-IT devices. Lastly, the company’s services business has seen solid growth over the past few quarters, partially benefitting from a partnership with Ericsson to help smaller Tier-1 and Tier-2/3 Service Providers migrate to NFV.
The cloud headwinds to revenues and near peak margins will pressure EPS growth in the near-term, in BAC’s view, implying stock appreciation would require multiple expansion, which may take time to materialize as it depends on the speed the company can offset the pressure on its legacy business and the velocity of new growth avenues, such as the move to recurring revenues. Only 18% of sales come from business lines that are currently good candidates for a move to cloud-based models, like security, wireless, and collaboration. The company’s legacy businesses, switching and routing, have some growth aspects and could benefit from situations like hybrid environments and platform solutions, yet the secular headwinds on the other parts of the business may drive a long transition period.
Limiting downside risk in BAC’s view is a 3.4% dividend yield and the potential for capital returns in the event of a tax repatriation holiday. BAC maintains its Neutral/$33 price target.