Using the Net to grow

The Internet is deeply woven into all aspects of Cisco Systems' business. But with high-tech stocks faltering, are riches still in store for the company?

[AP photo] Cisco Systems headquarters in San Jose, Calif.

By AMEET SACHDEV

© St. Petersburg Times, published June 5, 2000

SAN JOSE, Calif. -- The unstoppable growth machine of Silicon Valley isn't fueled by venture capitalists making dot-com deals over arugula salad at a trendy cafe. Nor by the estates of new-money multimillionaires in hillside enclaves.

To understand the source of this valley's riches, visit an immense office park a few miles north of downtown San Jose, Calif. The orderly sprawl of more than 40 low-slung, sand-color buildings is the headquarters of Cisco Systems Inc.

Cisco is the leading supplier of hardware for the Internet, and by any measure it's the envy of the high-tech economy.

It has enjoyed revenue growth of more than 50 percent every year. Over the past five years, its annual earnings growth has averaged almost 43 percent.

For investors, Cisco has been an awesome wealth machine. A single share from the company's initial public offering a decade ago, priced at $18 (but just 6.25 cents after nine stock splits), has a value of more than $18,000.

Thanks to Cisco's stock performance, for a few days in March it was the most valuable company on Earth. Its market value peaked at a half-trillion dollars but has since slipped behind General Electric Co. and Intel Corp.

Even if you're not a stockholder, Cisco's ascendancy matters because it is a testimony to the power of the Internet.

Companies born from bright ideas to sell clothes, cars and college educations online come and go -- lately, they've been mostly going -- but a company that provides the basic equipment of the new economy seems a solid bet.

Cisco is the top manufacturer of powerful systems that route and switch data packets among Web servers and Internet surfers. Now, the company is poised to help build the next-generation communications networks that carry voice, data and video at the speed of light. New digital networks will be necessary to meet the world's insatiable appetite for Internet and other communications services.

Cisco would like to connect everything with high-speed pipes: not just computers and telephones, but also mobile devices, home appliances, even cars.

Chief executive John Chambers, a 50-year-old, soft-spoken West Virginian, likens the Internet age to the dawning of a second industrial revolution. "The Internet is revolutionizing productivity," he said.

Cisco is still a corporate adolescent -- founded in 1984 by two computer scientists at Stanford University -- yet it offers some compelling lessons to other companies.

Proving the importance of leading by example, it incorporates the Internet into every aspect of its business. And it provides an awesome example of how to grow by acquisition, devouring smaller companies whenever they can help expand its product line.

As technology stocks have sagged in recent weeks, some analysts have warned that Cisco's stock is vastly overvalued and have questioned whether the mammoth company is just too big to keep growing at the same pace.

As more of Cisco's sales come from Internet service providers and new-breed telecommunications carriers, it's colliding head-on with two of its biggest rivals, Lucent Technologies Inc. and Nortel Networks Inc. Moreover, many red-hot upstarts want to eat Cisco's lunch in these new markets.

But mostly, Wall Street, the national business media and other technology executives remain in awe.

"Cisco has created an incredibly agile, powerful model," said Steve Raymund, chief executive of Tech Data Corp. in Clearwater, which distributes Cisco products. "It's exciting to be associated with a company like that."

Each morning about 13,000 employees enter Cisco City, the pleasant if bland corporate campus. Inside, the layout, the furniture, everything is identical. Frugality extends to the executive offices, which are only slightly larger than a typical office cubicle.

The egalitarian feel of the place is more than just window dressing. Cisco gives stock options to every employee. So many employees are millionaires that the head of human resources, Barbara Beck, can't remember how many the company has. (Chambers' options were worth nearly $500-million at the end of the company's last fiscal year that ended July 31.)

So it's easy to understand why Cisco receives more than 20,000 resumes a month. The company is hiring about 1,000 people a month and has 29,000 employees worldwide. Cisco is growing so fast that it has set aside land in south San Jose for a new campus that would house 20,000 employees. Just Friday, Cisco announced plans to build another complex in Richardson, Texas, that will have 4,000 workers. The company has managed such explosive growth by making full use of the Internet technology that has made the company prosperous. In doing so, the company has become a role model for the corporation of the new millennium.

Everyone who works for or with Cisco -- from employees to customers to suppliers -- is wired into the company.

About 90 percent of job candidates submit their resumes electronically.

After they are hired, employees typically tap the internal Web site more than 30 times a day for everything from ordering supplies to receiving training. Employees file expense reports and arrange benefits online. Managers use the Web to review employees and monitor sales.

Soon, workers with tots at Cisco's day-care facility will be able to monitor their youngsters from their desktops via Webcams.

Larry Carter, chief financial officer, loves the Web because he can "virtually" close the company's books any day of the quarter to gauge financial results. It helps him avoid the surprises that Wall Street hates.

Cisco began selling its wares online in mid-1995, before most companies had a Web site. Now, 85 percent of its orders, about $30-million worth a day, arrive via Internet. After the sale, more than eight out of 10 customer-support queries are handled on its Web site, saving the company $600-million this year, Chambers boasts.

The Internet also is woven deeply into Cisco's manufacturing operation. The company operates only three factories, in which it assembles its most sophisticated gear. The rest of its equipment is built in three dozen plants around the world run by contract manufacturers, such as Jabil Circuit Inc. of St. Petersburg.

Data connections guarantee that these manufacturers do exactly what Cisco wants, allowing it to send them test software, design files and order information.

"Cisco's approach to partnering has given them a real competitive advantage," said Mark Mondello, Jabil's senior vice president of business development. Cisco was Jabil's second-largest customer in the past fiscal year, accounting for $400-million in revenue, or 20 percent of Jabil's total sales.

In Silicon Valley, Cisco is known as the Borg, after the fearsome aliens on Star Trek that assimilate their enemies.

Under Chambers, Cisco has bought more than 50 companies valued at more than $30-billion, snapping up in the process their product innovations and their creative talent. For example, Cisco bought its way into the optical networking market by purchasing three companies last year for $9.5-billion.

The acquisitions were among 18 Cisco made in 1999. The company is halfway toward its goal to buy 20 to 25 companies this year. Says Ammar Hanafi, Cisco's director of business development: "Doing acquisitions is now wired into the DNA of the company."

Using its soaring stock as currency, Cisco scans the horizon for the next important communications niche, then buys the companies whose technologies will ensure Cisco will be No. 1 or No. 2 in every market. The company often relies on its customers for tips on what to buy. Chambers credits executives at Boeing Co. for steering him toward his first acquisition in 1993.

"The exit strategies of a lot of companies in the networking market is to be acquired by Cisco," said David Bunnell, author of Making the Cisco Connection: The Story Behind the Real Internet Superpower. "It's so weird because most of the time employees at the company being acquired are nervous."

To help ease the transition, the company has a team of three dozen staffers who work full time shepherding newcomers into the fold. The goal is to retain employees, especially engineers, who are the most significant assets Cisco is buying, Hanafi said. Its golden rule of mergers is that no acquired employee can be fired or reassigned without the consent of the acquired company's chief executive.

While Cisco has made a science of digesting acquisitions, the employees' newfound stock wealth helps, too. If the stock price doesn't keep growing, companies might not find it as enticing to sell out for what Bunnell calls "Cisco dollars."

That Cisco's growth is so intertwined with its stock price should give investors pause, said Martin Pyykkonen, an analyst at CIBC World Markets in San Francisco.

Even more so after Cisco's stock has fallen more than 20 percent since hitting an all-time high of $82 in March. Shares closed Friday at $64.38. Even after the decline, Cisco's shares are much more expensive than other established players in its field, as the financial weekly Barron's recently pointed out.

Chambers arrived at Cisco in 1991 as a senior executive after stints at IBM and Wang Laboratories. He was not some computer geek but rather a salesman. He's famously ingratiating. Before a presentation to a small group of reporters, Chambers gives out his business card and shakes hands just as a high school principal would hand out diplomas.

Chambers is obsessed with perfection, a trait he traces back to growing up with a learning disability, and it shows in the fast-paced presentations he delivers without notes.

He unabashedly peppers his speeches with phrases such as "We can change the way people live and work, play and learn" and "Cisco is positioned to lead the second industrial revolution." But with his soft Southern twang and gentle blue eyes, he doesn't come off as arrogant.

When Chambers became chief executive in 1995, Cisco had annual revenue of about $1.2-billion and a market value -- stock price multiplied by number of shares outstanding -- of $9-billion. The company was virtually unknown outside Silicon Valley. Employees joked that people often confused the company with Sysco, the food service distributor with the red, white and blue trucks.

Today, Cisco is on track to report revenue of more than $17-billion and operating profits of nearly $4-billion in the fiscal year that ends July 31, according to First Call/Thomson Financial. One giddy analyst predicted in February that Cisco would become the world's first company with a market value of $1-trillion.

The company is breaking ground by growing at a rate rarely seen in a large global company. Yet, Cisco has flawlessly executed quarter after quarter. The fiscal third quarter, which ended April 29, was the company's ninth consecutive quarter of higher revenue growth.

But as investors know all too well after the dive in technology stocks in April, nothing lasts forever. Instead of Cisco achieving annual revenue growth of more than 50 percent, "we're probably looking at more 40 to 50 percent growth as you go into next year," said Pyykkonen, the San Francisco analyst. "I think that's a more realistic level."

Beyond questions about its high valuation, analysts are hard-pressed to find clouds on Cisco's horizon. With the building of the Internet's backbone still in its early stages, Cisco is sitting pretty, Pyykkonen said. The company has diversified beyond its bread-and-butter routers and switches, which allow computer networks to "talk" to each other. It makes everything from expensive switches for telephone networks to devices that link homes to the Internet. It is now focusing on new ways of delivering data over high-speed fiber-optic lines and wireless networks. Much of this hardware depends on Cisco's software, an often overlooked piece of the empire.

The company has zeroed in on the $200-billion annual market for telecommunications equipment, which is five times larger than the data networking market.

Chambers also has set his sights on new markets for Internet telephone calls and Internet appliances, which are consumer devices that allow Web surfing from the kitchen or the den. Cisco's interest in routing phone calls over the Internet is so great that it gives each new employee an Internet telephone instead of a standard one.

But Cisco's domination of emerging markets, unlike the market for networking products, is hardly assured.

Rivals Lucent and Nortel are well-established suppliers to telephone companies. Moreover, start-ups, such as Juniper Networks Inc. and Sycamore Networks Inc., are developing high-end products that many analysts say outperform Cisco's.

In fact, Chambers recently told analysts that the company's greatest competitive threat comes not from the established players but from new, nimbler companies.

Chambers says: "It's going to be a war."

- Information from the Wall Street Journal was used in this report.

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