Cisco Valuation - Dividend Discount Model

Internet of Things-Cisco Valuation
Kenya Lopez
FIN 4370

One of the most recent innovation our generation is experiencing is the integration of Internet of Things (IoT). This means, that every day, more devices are connected each other sharing data with other applications, devices or even services.

IoT allows devices to be connected at home. For example, Echo Dot created by Amazon, it is a hand free device voice-controlled used to make calls, text, play music, control lights, thermostats, fans, and so forth. In fact, if one can think of one future innovation in this area is the self-driving car.

Companies as Google, Uber, Testla, and most manufacturers have been working in the development of self-driving cars and we might drive one by 2020. The connection between self-driving cars and IoT is that cars are imbedded with hardware capable of sensing what is happening 360 degrees around. With this, less accidents would occur. The reality is that IoT goes further, not only works in sellf-driving cars, or at home, but also in manufacturing, energy, transportation, smart cities, government, education, retail services and the financial industry. A great company that works with Iot is Cisco Systems Inc. (CSC0) a worldwide public corporation founded in 1984, and focuses on Networking & Communication Devices. Its headquarters are in San Jose California.

Cisco “designs, manufactures, and sells Internet Protocol (IP) based networking and other products related to the communications and information technology industry worldwide. It provides switching products, including fixed-configuration and modular switches, and storage products that provide connectivity to end users, workstations, IP phones, wireless access points, and servers; and next-generation network routing products that interconnect public and private wireline and mobile networks for mobile, data, voice, and video applications.” (Yahoofinance:CSCO) (yahoo finance) In addition, the company offer service provider of video infrastructure, wireless products, cloud manage solutions. They provide in their services data analysis, security, management, and automation.

Competitors and Market Capitalization :

GOOGLE 649.49B GE 223.20B ORACLE 206.67B

IBM 135.28B INTEL 170.57B MICROSOFT 561.13B

Microchip Technology Inc. 20.57B CISCO 159.00B

Industry Growth

The growth for IoT would impact every economic sector, manufacturing, transportation, agriculture, home and so forth; businesses, government, and public in general would interact with technology in a more sophisticated way. A summary published in Jul 2016 in Business Insider of a BI Intelligence’s study regarding the growth of IoT forecasted that:

there will be 34 billion devices connected to the internet by 2020, up from 10 billion in 2015. IoT devices will account for 24 billion, while traditional computing devices (e.g. smartphones, tablets, smartwatches, etc.) will comprise 10 billion.

Nearly $6 trillion will be spent on IoT solutions over the next five years.

Businesses will be the top adopter of IoT solutions. They see three ways the IoT can improve their bottom line by 1) lowering operating costs; 2) increasing productivity; and 3) expanding to new markets or developing new product offerings.

Governments are focused on increasing productivity, decreasing costs, and improving their citizens’ quality of life. We forecast they will be the second-largest adopters of IoT ecosystems.

Consumers will lag behind businesses and governments in IoT adoption. Still, they will purchase a massive number of devices and invest a significant amount of money in IoT ecosystems.

Cisco Financials

Annual Financial statements posted on MarketWatch show non-constant growth. Revenues has been decreasing from 2015 to 2016 to only .17% growth and in 2017 decrease even more to -2.52%. EBITDA which is a measure that indicates if the business is profitable because it reveals the amount of its normal operation earning it has almost the same path as revenue. Being negative for 2014 and 2017.

Column1	2013	2014	2015	2016	2017
Sales/Revenue	48.61B	47.14B	49.16B	49.25B	48.01B
Sales Growth	-	-3.01%	4.28%	0.17%	-2.52%

EBITDA	13.64B	11.87B	13.87B	15.12B	15.05B
EBITDA Growth	-	-12.97%	16.79%	9.07%	-0.51%

Net Income Available to Common	9.98B	7.85B	8.98B	10.74B	9.61B

Capital Expenditures	2013	2014	2015	2016	2017
	(1.16B)	(1.28B)	(1.23B)	(1.15B)	(964M)
Capital Expenditures (Fixed Assets)	(1.16B)	(1.28B)	(1.23B)	(1.15B)	(964M)
Capital Expenditures (Other Assets)	-	-	-	-	-
Capital Expenditures Growth	-	-9.91%	3.76%	6.60%	15.88%
Capital Expenditures / Sales	-2.39%	-2.70%	-2.50%	-2.33%	-2.01%
Net Assets from Acquisitions	(6.77B)	(2.99B)	(326M)	(3.16B)	(3.32B)
Sale of Fixed Assets & Businesses	-	232M	22M	413M	7M
Purchase/Sale of Investments	(3.92B)	(2.64B)	(8.38B)	(4.03B)	(1.75B)
Purchase of Investments	(36.83B)	(36.7B)	(44.2B)	(47.02B)	(42.92B)
Sale/Maturity of Investments	32.92B	34.07B	35.82B	42.98B	41.17B
Other Uses	-	-	(178M)	(191M)	-
Other Sources	74M	24M	-	-	39M
Net Investing Cash Flow	(11.77B)	(6.64B)	(10.09B)	(8.12B)	(5.99B)


Free Cash Flow	11.73B	11.06B	11.33B	12.42B	12.91B
Free Cash Flow Growth	-	-5.77%	2.42%	9.70%	3.93%

Ratios

Profitability Margin 20.02%

Return on Assets 6.3%

Return on Equity 14.81%

Current Ratio 3.4

Debt/Equity Ratio 50.98

Stock Evaluation

Cost of equity:

To determine the cost of equity Capital Pricing Asset Model is used. As risk free, I consider the U.S. 10-year treasury Note, which is 2.054 Beta equal to 1.48; For the market risk, I used the Year to date return of S&P 500 index which according to CNN Money is 9.94% Thus, the cost of equity is equal to 13.73%

Ke=2.054 + 1.48(9.94-2.054)

Ke= 13.73%

Cost of Debt:

According to Morningstart.com, the quote for a current yield 10 years bonds is 2.9%, and the effective tax rate for 2017 was 21.80% Obtain from Income Statement Yahoo finance data of 2017.

Cost of debt= .029 * (1-.2180) = .227

Market Capitalization

According to Yahoo finance, the company has 5 billion share outstanding, and the current price is $31.48. Its market value of equity equals $157.4 Billion.

31.48 * 5 =157.4

Capital Structure:

On the Balance Sheet Statement of 2016 Cisco has:

Short/Current Long Deb 7.99 B

Long Term Debt 25.73 B

Total Long-Term Debt: 33.72 B

Weight of Equity (WE)

WE= E/D+E

WE= 157.4 / 191.12

WE=.8236

Total Stockholder Equity: 66.14 B

To get a right percentage of the capital structure, we must consider weighs based on the market not on book value:

Weight of Debt (WD)

D+E=33.72+157.4 = 191.12

WD=D/D+E = 33.72/191.12

WD=.1764 %

Weight of Equity (WE)

WE= E/D+E

WE= 157.4 / 191.12

WE=.8236

Weighted Average Costs of Capital:

Weigth of Debt	Cost of Debt	Weigth of Equity	Cost of Equity
0.1764	0.022678	0.8236	0.137
WACC =		11.71%

Dividend Growth

Price	P/ QUARTER	ANNUAL	Growth
31.48	0.1162
2017	0.29	1.16	12%
2016	0.26	1.04	24%
2015	0.21	0.84	11%
2014	0.19	0.76	12%
2013	0.17	0.68

Arithmetic Average: 14%

Dividend Discount Model
				T value
2018	2019	2020	2021	2022
1.16	1.32	1.51	1.72
				39.074
				g=.10 r=.09

	2018	2019	2020	2021 + T value
Price	1.16	1.32	1.51	71.53
	(1+.1171)	(1+.1171)^2	(1+.1171)^3	(1+.1171)^4
	1.04	1.18	1.35	64.03

Price=	67.60

Analysis

Using the Dividend Discount model, I apply the arithmetic average growth of 14% per year from 2018 to 2021, and then I used a 9% constant growth over the remaining life of cisco obtaining a terminal value of $71.53 in the year 2021. I am using a lower percentage of growth because Cisco has not a constant increase in revenues, thus it is uncertain if the company would remain positives revenues. Discounting the future dividends, I obtain a price of $67.60. The price is undervalued, compare to the price today which as of September 8^th was $31.48. Thus, we can invest now in the hope of getting future rate of return. Even thought, the company does not reflect great financial number, they are expanding the financial statement shows and expenditure of 964 million in Capital expenditures. The ratios obtained from Yahoo Finance indicate a profitability margin of 20.02 By July 2017 a higher percentage than other as PayPal, at&t, and Microchip technology. Cisco has as well as higher percentage in Return on Assets which is 6.3% follow by Microchip Technologies Inc. 6.12%. Regarding Return on Equity, Microchip Technology has higher return but most of the companies selected are between 10.47% and 15.15%. Cisco’s Current ratio (3.4) is as well similar to, Microchip Technology (3.12). Thus, in general, cisco seems to be relativity similar to other companies, and a large market cap even greater then Intel and IBM. Considering the expectations of the market growth I consider that cisco is a good company to invest and has a high return on equity.

Works Cited

CNNMoney “S&P 500 INDEX” Web. Sep 10 2017.

http://money.cnn.com/quote/quote.html?symb=SPX

CSIMarket. “Cisco Systems's Annual Effective Tax Rate.” Sep 10 2017.

https://csimarket.com/stocks/singleProfitabilityRatiosy.php?code=CSCO&itx

Greenough, John. “How the 'Internet of Things' will impact consumers, businesses, and

governments in 2016 and beyond.” Web. Sep 10 2017. http://www.businessinsider.com/how-the-internet-of- thing s-market-will-grow-2014-10

Market Watch. “U.S. 10 Year Treasury Note.”

http://www.marketwatch.com/investing/bond/tmubmusd10y?countrycode=bx

Morningstar “Cisco Sys 2.95% | Maturity:2026” Web. Sep 10 2017.

http://quicktake.morningstar.com

Yahoo Finance. Summary. https://finance.yahoo.com