(The author is a Reuters Breakingviews columnist. The opinions
expressed are his own.)

By Robert Cyran

NEW YORK, May 16 (Reuters Breakingviews) – Cisco Systems’
(CSCO.O: Quote, Profile, Research) stock evidently benefits from the luxury of low
expectations. The U.S. networking giant’s quarter to April was
only mediocre. But John Chambers, the chief executive, said on
Wednesday evening that the economic outlook is improving
slightly, margins aren’t shrinking and sales are rising as
expected. The stock then rocketed more than 10 percent. At that
rate, truly good news could make the CEO look a hero.

An essentially lost decade following the dot-com boom left
investors skeptical of Cisco and Chambers. The company wasted
capital expanding into fields only loosely related to
networking. And a loss of focus encouraged rivals to attack its
core switch and router market. In 2011, Chambers issued
something of a mea culpa and began cutting costs, slowing the
pace of acquisitions, increasing share buybacks and paying a
dividend. Cisco now aims to give back half of cash flow to
investors.

Trust, however, can’t be regained quickly. And one added
concern was that software from startup companies could replace
physical routers and switches in some uses, eating into Cisco’s
sales and margins. Cisco’s stock tumbled from a 2010 post-crisis
high well above $25 a share to under $15 by mid-2011. The fact
that it had recovered to a level above $20 even before
Wednesday’s announcement says more about how far it had fallen
than any great optimism.

That may now be changing, but investors still seem
skeptical. Cisco’s 63 percent gross margin in the most recent
quarter – the same as a year ago, and slightly better than the
prior quarter – shows the company’s products are far from
becoming run-of-the-mill. Sales are improving steadily and could
increase by up to 7 percent this quarter from a year before. And
even after the post-earnings pop, Cisco’s stock is trading at
less than 12 times estimated earnings for the current fiscal
year.

If quarterly earnings that met undemanding expectations and
a decent but unexciting outlook can bring a double-digit gain,
shareholders would surely be ecstatic if Cisco produced
unexpectedly good earnings in coming quarters. If Chambers can
pull that off as he approaches retirement in the next few years,
it would give him a pleasing finale.

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CONTEXT NEWS

– Cisco Systems on May 15 reported net sales of $12.2
billion for the quarter ending April 27, an increase of 5
percent from the same period last year. Earnings rose 15
percent, to $2.5 billion or 46 cents a share.

– The company reported after the market closed. In morning
trade in New York on May 16, Cisco’s shares were up more than 12
percent at around $23.85 apiece.

– Cisco statement: link.reuters.com/run28t

– Reuters: Cisco profit beats Street, shares rise on outlook
[ID:nL2N0DW3AB]

RELATED COLUMNS

Red Queen’s race [ID:nL2E8IV4JP]

Now the reward [ID:nL4E8JG1TG]

– For previous columns by the author, Reuters customers can
click on [CYRAN/]

(Editing by Richard Beales and Martin Langfield)

((robert.cyran@thomsonreuters.com)(Reuters messaging
robert.cyran.thomsonreuters.com@reuters.net))
Keywords: BREAKINGVIEWS CISCO/

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The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Over the past decade, Nuance Communications has been on a frenetic shopping spree. The $6 billion firm now encompasses businesses ranging from medical transcription to powering Siri on the iPhone. But Nuance, the M&A machine, is sputtering. Margins are falling, the stock hasn’t advanced in five years, and debt is accumulating. Moreover, Carl Icahn recently upped his stake in the company from 9 percent to 11 percent in what could signal an end to acquisitions – even the start of a breakup.

Acquisitive companies in fragmented industries often follow a similar trajectory. At first, growth is easy, with a plethora of rivals to buy. Investors, excited by fast expansion, attach a high multiple to the company’s stock, allowing it to buy rivals cheaply and putting a higher value on the acquired profits. As a company gets bigger, though, it needs more or larger deals to grow. And managing all the acquisitions, never mind integrating them into a cohesive whole, becomes more difficult as size increases.

After laying out roughly $4 billion on purchases, Nuance now appears to have hit this familiar wall. Routinely spending more on acquisitions than the company’s free cash flow means debt has rapidly increased to $2.3 billion. Organic growth has stalled, and the company was in the red last quarter. Nuance blamed trouble integrating recent acquisitions. Falling margins in all its businesses may signal deeper problems. Furthermore, free cash flow is falling.

This could be merely a quarterly hiccup. A recently announced $500 million stock buyback could rev up Nuance’s shares, making them a valuable currency again. Plans to slow its acquisition pace and focus on smaller companies could be the pause that refreshes. And the company thinks organic revenue growth should resume in 2014. But the buyback may simply reduce the amount of dry powder the company has on its balance sheet for deals.

Icahn’s presence should act as a further brake. He is a passive investor now. But his investment history suggests that will change if Nuance’s position worsens. Icahn likes to tell companies to simplify themselves. Nuance has no shortage of well-defined operations such as medical, enterprise, and consumer that could be sold or spun off. One more stumble, and Icahn’s views will become clearer – and probably won’t involve much nuance.

Elliott Management has once again pushed a technology firm into selling itself. This time BMC Software is going for $6.9 billion to a private equity group led by Bain Capital and Golden Gate Capital. At $46.25 a share, the 2 percent headline premium over Friday’s closing price may seem tiny. But that’s more than a 30 percent return for Elliott, adding to its record of similar successes at Novell, Packeteer and Blue Coat.

BMC was a prototypical case of a tech company that lost its mojo. Its software for running mainframe computers is solidly profitable. But public market investors don’t like businesses that are in long-term decline as their customers gradually shift to newer technologies. BMC’s server and network business has better long-term prospects, but growth has been sluggish. On top of that, BMC’s margins were lower than those at bigger peers, and management had squandered capital on acquisitions in an attempt to stay relevant.

Tech zombies can, however, wander about for years – and throw off a lot of cash in the process. BMC, for example, has been touted as a potential takeover candidate for the past decade. Elliott emerged as a big investor in BMC in early 2012. While the stock quickly rose from around $35 when news of the fund’s involvement broke, it took about a year of effort to actually achieve a sale. The campaign included public pressure for a sale, a proxy fight, the appointment of two new directors to the board, and ultimately a successful auction.

Plan A was probably for a deep-pocketed rival to pay up for BMC. But with Hewlett-Packard and Dell struggling, IBM out of the picture for antitrust reasons, and SAP and Oracle consumed with bigger battles, that didn’t happen. The relatively predictable nature of BMC’s enterprise software business – in contrast, say, to Dell’s more quickly declining PC operations – and its relatively unlevered balance sheet ensured that as an alternative there would be private equity interest.

Not only did Elliott stick to its guns, a characteristic also evident in the firm’s pursuit of Argentina over defaulted bonds, the fund also picked its target so that even Plan B stood a good chance of proving profitable. Flightier would-be activists could learn from that.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A PepsiCo breakup looks like a matter of time. Investors with a hankering for corporate restructurings have taken stakes in the $128 billion snacks and drinks conglomerate. Splitting the two operations in some way would be straight out of their standard playbook. Though the company has opposed such efforts in the past, the success of Nelson Peltz at Cadbury and his interest in another food biggie, Mondelez, may be hard to resist.

Peltz has successfully prodded the food industry for years. He purchased Snapple for $300 million in 1997, fixed it, and flipped it to Cadbury three years later for $1.5 billion. In 2008, he convinced Cadbury to spin off Dr Pepper Snapple. Two years later, the British confectioner was gobbled up by Kraft at a premium. About 18 months later, he helped push Kraft to divvy up its portfolio into a stable grocery business and a faster-growing collection of brands, albeit with an awful name, Mondelez.

Peltz’s emergence as a Pepsi owner has increased breakup talk. Pepsi chief Indra Nooyi has argued there are $1 billion of synergies from keeping the firm whole. Having the same trucks deliver Doritos and Mountain Dew cuts costs. Moreover, Pepsi is widely sold in developing nations – that’s a ready-made distribution chain for expanding snack sales in these countries. While the uppity investors only control about 2 percent of the stock, they have two powerful arguments. Pepsi shares have underperformed pure-play rivals like Hershey and Dr Pepper over the past five years. And history suggests more specialized firms boast better capital allocation, and higher margins and sales growth.

Consider Dr Pepper. The spin-off concentrated solely on soda, while a heavy debt load focused executives’ minds on costs. Margins and market share have since risen, and the stock has doubled. Splitting off the North American beverage unit might similarly encourage Pepsi to hawk more high-margin sugary drinks instead of healthy fare. While bad for waistlines, it might be good for the stock. Dr Pepper’s investors have done more than twice as well as Pepsi’s over the past five years.

As for Pepsi’s snack rump, Peltz now has a $1.3 billion stake in $56 billion Mondelez, according to CNBC. Slamming the two groups together could save $3 billion of costs annually, according to Bernstein Research. That’s worth $20 billion of additional market value. This is just one of many possible outcomes – including no action whatsoever. But financial logic and Peltz’s dealmaking history suggest it may not be long before activists seize the upper hand.

NEW YORK (Reuters Breakingviews) – Apple’s (AAPL.O: Quote, Profile, Research) $50 billion increase in its share buyback program is a sign it is hitting middle age. The company is slowing down a bit. But the $380 billion Apple still has plenty of spring in its step. And its absurd level of financial comfort means it can give much more back to investors.

Apple’s 11 percent revenue growth in the quarter to March from a year earlier was well short of its previous breakneck pace. And the company’s gross margin slipped to 37.5 percent and may fall further – enviable for most companies, but not up to Apple’s innovative best. The company blamed factors ranging from increased sales of lower-margin iPads to changes in service policies in China.

Perhaps more telling is that the average selling price of an iPhone dropped by $20. Apple’s ability to inspire fans to pay luxurious prices for its latest goods has weakened – or perhaps with such huge scale it now has to tap less affluent customers.

But Apple isn’t yet 40 and it’s too early to talk of decline, let alone decrepitude. Rivals such as Samsung (005930.KS: Quote, Profile, Research) are capturing a larger chunk of the expanding global market. But Apple’s sales of smartphones are still rising, and tablets are booming with 65 percent more iPads sold in the recent quarter than a year earlier. Moreover, Chief Executive Tim Cook promises new products in the fall. Apple might even beat the odds by introducing another device that creates a whole category.

A degree of aging also means financial security and a plan for the firm’s cash pile, which has reached an astonishing $145 billion. That’s far more than Apple needs, especially since to date at least it has wisely refrained from big acquisitions. The company is more than doubling the amount destined for shareholders’ pockets to $100 billion by the end of 2015.

That will make Apple the largest dividend payer in the world, according to the compilers of the S&P 500 Index. And the company has upped its planned share repurchases to $60 billion from $10 billion – a sensible move while the stock looks undervalued on several metrics. David Einhorn, the vocal hedge fund manager, might prefer payouts structured his way. But other shareholders could justifiably conclude Apple is transitioning to maturity, not a mid-life crisis.

CONTEXT NEWS

- Apple on April 23 reported revenue of $43.6 billion for the quarter ending March 30, an increase of 11 percent from the same period last year. Net income decreased 18 percent to $9.5 billion.

- The company sold 37.4 million iPhones in the quarter, 19.5 million iPads and 4 million iMacs.

- Apple also more than doubled to $100 billion the amount of capital it plans to return to shareholders by the end of 2015. As part of this plan, the company increased its quarterly dividend by 15 percent to $3.05 per share and its share buyback authorization from $10 billion to $60 billion.

- Apple will borrow in conjunction with the program. The company has $145 billion of cash and investments on its balance sheet, but a majority is overseas. Repatriating it would trigger a tax liability.

- Company statement: link.reuters.com/xyz57t

RELATED COLUMNS

- For previous columns by the author, Reuters customers can click on (Editing by Richard Beales and Martin Langfield)

Will Netflix have a starring role in “The Easter Island Effect”? The Internet video service seems to be using up resources faster than it can produce them. New series like “House of Cards” lure customers, at a cost. Netflix cash flow remains negative and obligations are rising. It’s starting to evoke the centuries-old Polynesian society that eventually exhausted its means of sustenance.

After some strategic missteps, Netflix has pleased the investment gods again. An 18 percent rise in revenue in the first quarter from a year ago helped the company’s shares to surge by nearly a quarter, adding $3 billion of market value. The heavily shorted stock has quadrupled from a recent low last July.

The company’s disruption of the entertainment ecosystem also is expanding. Adding another 2.4 million paying U.S. streaming customers – bringing the total to almost 28 million – will be a further catalyst for more services that don’t require a cable or satellite subscription. What’s more, the success of new series like the 13-episode thriller “House of Cards” and the highly anticipated “Arrested Development,” made available all at once, are altering behavior with a binge-viewing option and forcing broadcasters to confront TV’s long-standing linear model. Both trends could threaten carriage and advertising revenue.

The durability of Netflix’s growth, however, is questionable. Free cash flow drained away again, with a $42 million shortfall in the latest quarter. Its balance sheet is also looking increasingly depleted. Include $3.3 billion of off-balance-sheet items, and programming obligations grew from under $5 billion last year to $5.7 billion.

Moreover, content resources could become more precious. Netflix Chief Executive Reed Hastings said Amazon and Hulu are bidding more aggressively for the same films and programs. Netflix reckons its capital position is just fine, with $1 billion in cash and short-term investments on the balance sheet.

Even so, the inhabitants of Easter Island discovered the hard way the perils of underestimating the shorter-term price of growth. Netflix will need to husband capital or find a way to generate more of it to avoid becoming just a curiosity of financial anthropology.

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The mafia and Cyprus could trigger a full release of animal spirits. High debt didn’t deter buyers from this month’s Intelsat and SeaWorld initial public offerings. Now comes Qiwi, a Cyprus-domiciled, Russian payment system warning about the potential effects of organized crime, the island’s bailout, money laundering and a dual-class share structure. It puts investor appetite to the ultimate test.

Any appeal will partly derive from providing an alternative to Russia’s heavy reliance on cash. Qiwi operates about 170,000 kiosks that enable consumers to pay bills and top up mobile phones without physical rubles. It also lets customers set up digital wallets to buy items online or make peer-to-peer transfers. Qiwi increased net revenue by 28 percent in 2012, but its digital wallet business grew 80 percent and now accounts for almost a third of sales. The company is also solidly in the black.

Such growth is tempting, considering Qiwi’s room to expand in Russia and other nearby cash-dependent countries. It’s also reasonably cheap. If net income grows at the same pace as last year and the shares sell at the middle of the mooted price range, Qiwi would be valued at about 14 times earnings.

The fear factors will have something to do with that. Qiwi spells out rather plainly Russia’s history of corruption, crime and political problems. The company has experienced it first-hand, too. A Moscow court ruled that an aluminum company used Qiwi’s kiosks to launder money.

Incorporating in the offshore haven of Cyprus could mean Qiwi gets asked to help foot the country’s economic or military expenses, it cautioned in the prospectus. There are other legal hazards, too, given there’s virtually no legislation covering electronic payment in some jurisdictions where it operates. Investors also won’t have any real say in how Qiwi is run. Super-voting stock means insiders will keep control of 97 percent of the votes.

Heavy debt is at least measurable when contemplating an IPO like Intelsat’s or SeaWorld’s. In this, case, though, it’s hard to imagine a more toxic mix of unquantifiable, yet equally real, risks to an investment. If Qiwi shares can be sold, it’ll be a small but significant indicator of the market’s mob mentality.

Royalty Pharma is suffering from some self-inflicted wounds in its hostile pursuit of Elan. The finance firm tried to use the drug maker’s $1 billion stock buyback to swoop up the entire company. But it devised a puzzlingly complex tender offer that was too clever for its own good. The scheme ended up replacing a long-term shareholder with other investors far more likely to demand a chunkier premium.

Elan is largely a cash shell after selling most of its share in multiple sclerosis drug Tysabri earlier this year for $3.25 billion. Royalty lobbed in a $6.6 billion bid, or $11 a share, in February. Elan’s decision to buy back $1 billion of stock and return 20 percent of its remaining royalties from the drug to shareholders helped push the stock above the offer price.

Elan chose what’s known as a reverse Dutch auction for the buyback, offering $13 a share and then going lower until enough investors bit. Royalty responded with a revised, complicated bid: if the investors settled on $11.75 to $12 a share in the auction, Royalty would offer $12 a share for the entire company. If the strike price was more than $12.25, it would pay $11. If it was lower than $11.75, it would offer less on a sliding scale.

The offer contained both carrot and stick, signaling that Royalty would pay up to $12 but not more. Royalty added yet another tweak by saying it would hold back $1 a share off the offer price until after winning the company if Elan refused to reveal the size of its cash hoard.

Few shareholders were willing to sell for less than $13, aside from large stakeholder Johnson & Johnson – it wanted out, but was not too price-sensitive. It represented 92 percent of the shares tendered at the strike price of $11.25. J&J isn’t talking, but its actions imply it thought Royalty’s bid either contained too many conditions or the finance firm wouldn’t raise the price sufficiently to succeed.

Now Royalty’s offer is below Elan’s market price of $11.90 and getting its hands on the company is likely to require paying a fair whack more than what seemed to be its $12-a-share maximum. That’s a poor advertisement for complexity.

Financiers typically turn away fees as willingly as dogs give up steaks. But Wall Street banks are leery of financing bids for gun maker Freedom Group for fear of damaging their reputations. Making assault rifles, it turns out, has joined pornography on the list of activities with risks that money can’t hide.

Despite a welter of mortgage-lending, Libor-fixing and money-laundering scandals over the past several years, banks still worry over their images. That’s why they have reputational risk committees which judge whether investments are suitable. Members of senior management, legal, investor relations and other departments make decisions based on squishy metrics including how the public views a business, how likely are any protests to surface, and how much money is at stake. The sale of Freedom Group set off alarm bells for at least some lenders.

The company isn’t just any old gunsmith. It’s the largest maker of assault rifles in the United States and made the Bushmaster model which was used to kill 20 students and six teachers in a Newtown, Connecticut school last December. After that massacre, owner Cerberus Capital Management put Freedom Group on the block.

While lawmakers in Washington are only gingerly tackling the idea that some guns are more dangerous than others, this turned out to be an easy distinction for several reputational risk committees to make. Lending to a producer of shotguns used to shoot ducks is still good business; but aiding a big maker of semiautomatics is a publicity disaster waiting to happen.

This cold shoulder from lenders could make selling Freedom Group more difficult. The firm had $156 million of EBITDA last year. Put on the same multiple as Sturm Ruger it would be worth more than $1 billion. That’s big enough that many buyers would need to borrow. No loans would mean fewer potential buyers and probably a lower price. That’s why Cerberus co-founder Stephen Feinberg may gin up a stalking horse bid to encourage others.

The broader message, though, may be that at least for the public bankers worry about, manufacturing assault rifles is now one of the few industries that’s beyond justification in financial terms. Politicians might consider just how rare that is.

By Robert Cyran

NEW YORK (Reuters Breakingviews) – Facebook’s (FB.O: Quote, Profile, Research) new super-app wants to live off Google (GOOG.O: Quote, Profile, Research). The social network’s Home software, unveiled on Thursday, sits on top of the Android smartphone operating system. That encourages people to use Facebook over rival services. Google built Android, but Mark Zuckerberg’s company plainly likes the idea of grabbing a piece of it.

Android came to exist partly because Google didn’t want one company, Apple (AAPL.O: Quote, Profile, Research), controlling the software running all the world’s smartphones and tablets. By developing its own operating system, Google could ensure that services such as Gmail, YouTube and its search engine would run smoothly on phones and tablets – and that it would collect advertising dollars.

The huge success of Android – now powering over half of all U.S. smartphones, according to Comscore – owes much to its being freely available to any hardware maker, in stark contrast to Apple’s closed approach. Now, though, just as Google marshaled the Internet through its service and made money out of doing so, Facebook’s new software largely supplants the Android interface for users.

In Home, pictures and messages from friends will appear on a device’s lock and home screen, users can text each other directly, and notifications will pop up. Other services like video and search will surely appear soon. In short, people will have more reasons and require fewer screen-taps to use Facebook’s tools than Google’s Gmail, YouTube and the like. That in turn will probably mean more advertisements served by Facebook and fewer by Google, especially considering the 680 million active monthly users that Zuckerberg’s company claims.

Google’s wariness over Facebook has increasingly morphed into active rivalry, as evidenced by the search giant’s attempts to build its own social network, Google+. Facebook in turn moved into core Google territory, launching a search service earlier this year. The nature of the Home software potentially aggravates these tensions.

Google faces limits, however, in how it can react. Restricting access to Home might annoy users and bring antitrust regulators calling. But it shouldn’t surprise anyone if future tweaks to Android make Google’s services slightly more prominent, smooth and speedy than Facebook’s. If the social network wants to take a bite out of Google, the feeling assuredly is mutual.

CONTEXT NEWS

- Facebook on April 4 unveiled its new Home software for mobile devices running Google’s Android operating system. Home acts as an interface on smartphones and similar gadgets, displaying Facebook newsfeeds and messages on a device’s home screen.

- Home will be available as a download starting on April 12, and will initially work on a limited number of devices. It will come pre-installed on the HTC (2498.TW: Quote, Profile, Research) First handset, which goes on sale on April 12 through U.S. carrier AT&T (T.N: Quote, Profile, Research).

- Facebook announcement: link.reuters.com/zeh27t

(Editing by Richard Beales and Martin Langfield)